We regularly review our deferred tax assets and related valuation allowances in accordance with SFAS No. 109, “Accounting for Income Taxes” SFAS No. 109 requires us to assess all available evidence, both positive and negative, to determine whether a valuation allowance is needed based on the weight of that evidence.
During fiscal year 2002, we incurred a loss from continuing operations of $7,384,000. These losses exceeded our projected operating results and resulted in a three-year cumulative loss position. Cumulative losses are a form of evidence under SFAS No. 109 that is among the most objectively verifiable and carries more weight than other evidence that embodies some degree of subjectivity such as projected future income. As a result of this negative evidence, we determined that it is more likely than not that certain future tax benefits will not be realized. For the year ended July 31, 2002, we recorded a tax benefit based on the effective tax rate and offset the tax benefit with an increase in the deferred tax asset valuation reserve. In addition, we recorded income tax expense of $3,954,000 (net of a tax refund of $280,000 received during the third quarter of fiscal 2002) during the period primarily due to an increase in the valuation allowance related to our previously recorded deferred tax assets. As of July 31, 2002, all of our deferred tax assets were offset by a valuation allowance.
Net revenues for Zila Nutraceuticals for the year ended July 31, 2002, were $19.6 million, a 27.2% increase, compared to $15.4 million for the corresponding 2001 fiscal year. Sales of Ester-C® increased 22.9% over last year. The increase is attributable to increased radio and television advertising of the Ester-C® products in the first half of the current fiscal year. Sales of saw palmetto products increased 69.4% in fiscal 2002 over the prior year. International sales for Zila Nutraceuticals during the year increased 12.4% to $4.6 million compared to $4.1 million in the previous year.
As of July 31, 2002, approximately $3.8 million of saw palmetto products remained in inventory, representing approximately 1.6 years supply based on fiscal 2002 sales. During fiscal 2002, we reduced the carrying value of the saw palmetto inventory by approximately $550,000 because the market value of the product was less than its carrying value and due to spoilage.
In the last half of fiscal 2002, we increased the sales price of saw palmetto oil products. Sales volume in the fiscal fourth quarter decreased as a result of the price increase. However, sales in first quarter of fiscal 2003 have improved over the previous quarter, though not at the same volume as in the quarters prior to the price increase. We continue to sell the products at the higher sales prices.
Ascorbic acid is the major raw material in our Ester-C® products and is subject to periodic price fluctuations. The price of ascorbic acid has increased approximately 43% during the first quarter of fiscal year 2003. This price increase will cause our material component of the cost of goods sold to increase approximately 11% in fiscal 2003.
Zila Pharmaceuticals had net revenues of $15.2 million for the year ended July 31, 2002, a .4% increase over the $15.1 million recorded last year. Sales of the three Zilactin® canker and cold sore medicines for fiscal 2002 decreased 10.2% from those in fiscal 2001. Sales of the Zilactin® Toothache Swabs for fiscal 2002 decreased 20.3% over the previous year while sales of the Zilactin® Baby declined 25% over the previous fiscal year. International sales for fiscal 2002 were $596,000, an increase of 18.9% when compared to fiscal year 2001. The overall decrease in sales was due primarily to several new competitive product introductions during the year and the adverse effects on consumer demand caused by the events of September 11, 2001. Several initiatives were started during the second half of fiscal 2002 in an effort to increase sales, including new package design for all Zilactin® products, a new consumer and professional advertising campaign, increased level of public relations activities and the release of the new Zilactin® Baby Teething Swab products. Net sales of the Peridex® product increased 12.3% to $4.0 million in fiscal year 2002 due primarily to increased purchases from Omnii Products related to their exclusive supply agreement and lower product returns. Sales for the IST division were $1.2 million compared to $521,000 last year. Sales in fiscal 2001 included only six months of shipments because IST was acquired in February 2001. In July 2002, IST received a contract to produce two new products for a United States based healthcare company. The contract is expected to generate over $2.5 million in revenue through October 2004.
Cost of products sold as a percentage of net revenues for the Pharmaceuticals Group increased slightly to 32% during the year ended July 31, 2002 from 29.7% in the previous year. The increase is the result of a decrease in the average selling price of most of the Zilactin® products sold during fiscal ear 2002 and related additional manufacturing costs, the inclusion of IST costs of products for the entire twelve-month period of fiscal year 2002 versus six months in the prior year and the write off of expired inventory.
Zila Biotechnology
Research and development expenses decreased $211,000, or approximately 18.4%, from $2.5 million in fiscal year 2001 to $2.3 million for the same period in fiscal year 2002. The decrease was primarily due to reduced spending on the OraTest® product clinical trials because of our CRO’s decision to exit from the business of providing such services.
General and administrative costs increased $501,000, or approximately 77%, from $655,000 in fiscal year 2001 to $1,157,000 in fiscal year 2002. This increase was due to higher compliance and personnel costs in 2002.
Inflation and Seasonality
Inflation has had no material effect on the operations or financial condition of our businesses. Our consolidated operations are not considered seasonal in nature.
Liquidity and Capital Resources
The Company experienced two significant non-recurring events in 2003 which greatly affected our liquidity and cash position. First was the approximately $14.8 million net proceeds we received as a settlement with our former CRO. Second was the sale of our PracticeWares Inc. common stock in which we received approximately $525,000. While these two events represented non-operating transactions, they improved our balance sheet by improving our working capital, reducing debt and granting us increased financial flexibility over our recent past.
At July 31, 2003, our primary sources of liquidity which we define as our ability to generate cash from operations included cash and cash equivalents of $16.2 million and the line of credit discussed below. This compares to cash and cash equivalents of $1.6 million at July 31, 2002. Excess cash and cash equivalents are invested primarily in money market accounts. Our working capital was $22.0 million at July 31, 2003 compared to $10.8 million at July 31, 2002. The primary reason for the increase in working capital is the $14.8 million in net cash proceeds from the settlement with our former CRO offset by an increase in accounts payable. Our current ratio was 2.9 at July 31, 2003, compared to 2.5 at July 31, 2002.
Net cash provided by operating activities was $15.9 million for the year ended July 31, 2003. Our net income of $7.3 million was augmented by non-cash items of $6.2 million related primarily to depreciation, amortization and the effect of the adoption of FASB No. 142 which resulted in an impairment charge of $4.1 million and a $4.1 million net increase in operating liabilities, offset by a $1.7 million net increase in operating assets. Significant changes in operating assets and liabilities were primarily comprised of (i) an increase in accounts receivable of $1,856,000 due to increased sales in the fourth quarter of 2003 vs. the fourth quarter of 2002; (ii) a decrease in inventory of $780,000 related primarily to the increased sales of the Palmettx® and Ester-C® products; and (iii) an increase in accounts payable and accrued expenses of $4.1 million.
Net cash used in investing activities was $1.5 million, related primarily to $1.9 million used for capital asset purchases offset by proceeds received from the sale of PracticeWares common stock of $525,000.
Net cash provided by financing activities was $230,000 primarily related to the issuance of common stock and the $500,000 PharmaBio investment, offset by the pay down of the outstanding principal balance of the bonds related to Zila Nutraceuticals facility and other financing arrangements.
Due to the former CRO settlement, a significant portion of federal net operating loss (“NOL”) and all of the state NOL was absorbed. At July 31, 2003, we had NOL carry forwards for federal tax purposes of approximately $6.4 million, which expire in years 2021 and 2022. For state income tax purposes, the entire NOL carry forward was utilized. Our ability to utilize the federal NOL carry forward may be impaired if we continue to incur operating losses.
On August 14, 2003, we settled claims brought against the Company by Matrixx Initiatives, Inc. (“Matrixx”) a major customer of our IST Products operations. Under the settlement, Matrixx withdrew all its claims against us and accepted our price increase on swabs and our current production level. Our existing contract with Matrixx was extended by 90 days to March 31, 2004, but it is unlikely that the contract will be renewed at that time.
On August 27, 2001, we entered into a Loan and Security Agreement (the “Congress Agreement”) with Congress Financial Corporation (“Congress”) whereby Congress would provide a $12 million revolving line of credit to us at an interest rate equal to the prime rate plus 3/4 percent. The amount of funds available to us from the line of credit is based upon a percentage of the value of eligible receivables and inventory and was $8.4 million at July 31, 2003. Upon receipt of the $14.8 million net proceeds cash settlement with our former CRO on June 30, 2003, we immediately paid off the outstanding Congress balance of approximately $1.3 million. The obligations under the Congress Agreement are collateralized by various assets, including, but not limited to our trade accounts receivable, inventories, equipment and intangible assets and of certain
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of our operating subsidiaries. Zila and all of its direct and indirect operating subsidiaries guarantee the obligations under the Congress Agreement. The Congress Agreement expires August 17, 2004. The Congress Agreement contains a provision whereby Congress can call for immediate repayment of all amounts due under the line upon its determination that the Company has incurred a “material adverse change.” While we do not believe that any events have occurred in fiscal 2003 that would constitute a material adverse change, that determination is solely the responsibility of Congress. Under the Congress Agreement, we are also required to comply with a financial covenant based on an adjusted tangible net worth calculation. At July 31, 2003, our adjusted tangible net worth as defined was $ 32.3 million compared to a required amount of $12.0 million. If we continue to incur additional operating losses, reduce the value of our tangible assets, or incur additional debt, we may become out of compliance with the covenant. We are currently negotiating with several local asset based lenders who we believe can provide terms and conditions better than Congress because we now satisfy the requirements for the customer base they are pursuing.
In the course of its business, Zila Nutraceuticals purchases ascorbic acid from several direct and broker-arranged suppliers. In May 2003, Zila, Inc provided a continuing guaranty to one such broker for up to $2 million of ascorbic acid purchases made by Zila Nutraceuticals, Inc.
In March 2001, the Nutraceuticals Group sold the land and buildings related to its former operation in Prescott, Arizona for approximately $1.0 million in cash and a promissory note for $310,000. The note carried interest of 10% and was due and payable on May 31, 2002. After an extension, the note was paid off in December 2002.
On February 5, 2001, we issued 100,000 shares of Series B Convertible Preferred Stock (“Series B Preferred”) as part of the IST acquisition. The holders of the Series B Preferred Stock are entitled to receive cumulative quarterly dividends at a rate of $0.0975 per share per fiscal quarter, payable in arrears. We paid $49,000 and $29,000 in dividends in 2003 and 2002, respectively, and we accumulated accrued dividends of $19,500 as of July 31, 2003. The Series B Preferred can be redeemed at our option if our common stock maintains a closing price on each trading day equal to or greater than $9.00 per share for any ten trading day period. The redemption price shall be the average bid closing price on our common stock for the five trading days immediately proceeding the date we give notice. The Series B Preferred shall be convertible at the option of the holder at any time on or before December 31, 2010 into our common stock at the ratio of one-to-one. On December 31, 2010, all of the remaining Series B Preferred will be converted into our common stock at a ratio of one-to-one.
During October 2000, Zila Nutraceuticals moved into its new manufacturing and laboratory facility in Prescott, Arizona. The facility was financed through a transaction with The Industrial Development Authority of the County of Yavapai (the “Authority”) in which the Authority issued $5.0 million in Industrial Development Revenue Bonds (the “Bonds”), the proceeds of which were loaned to the Inter-Cal Corporation (now know as Zila Nutraceuticals, Inc.) for the construction of the facility. The Bond proceeds were held by the trustee, Bank One, Arizona, until such time as invoices for building construction costs and new equipment were submitted for payment. As of July 31, 2001, the trustee had released all the Bond proceeds. As of July 31, 2003, the Bonds outstanding consist of $3.6 million Series A which carried an interest rate of 1.1%. The Bonds were marketed and sold by Banc One Capital Markets and carry a maturity of 20 years. In connection with the issuance of the Bonds, the Authority required that Oxycal obtain, for the benefit of the Bondholders, an irrevocable direct-pay letter of credit to secure payment of principal and interest. The letter of credit was issued by Bank One, expires in March 2004 and is guaranteed by Zila. Bank One has notified us that they will not replace the current letter of credit due to our past financial performance not meeting their minimum requirements. The Authority requires that a letter of credit remain in effect until the Bonds are paid in full. Currently, we are in the process of evaluating financial institutions and anticipate we will be able to secure a replacement letter of credit. However, if we are unable to obtain a new letter of credit we will be obligated to pay off the bonds in full. Payment for these bonds will come from our cash balances and operating cash flow.
On November 10, 1999, we announced that our Board of Directors authorized the repurchase of up to one million shares of Zila common stock. Purchases will be made on the open market depending on market conditions and other factors. During 2003, 30,100 shares were repurchased. As of July 31, 2003, 225,100 shares had been repurchased for $571,373.
The table below summarizes our future cash contractual obligations by at July 31, 2003, and the effect that such obligations are expected to have on our liquidity and cash flows for fiscal years ending July 31.
| | 2004 | | 2005 & 2006 | | 2007& 2008 | | Thereafter | | Total | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Long-term debt | | $ | 487,449 | | $ | 927,707 | | $ | 851,568 | | $ | 1,948,851 | | $ | 4,215,575 | |
Operating leases | | | 403,380 | | | 382,711 | | | 103,951 | | | | | | 890,042 | |
Purchase obligations | | | 5,899,000 | | | | | | | | | | | | 5,899,000 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total | | $ | 6,789,829 | | $ | 1,310,418 | | $ | 955,519 | | $ | 1,948,851 | | $ | 11,004,617 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Purchase obligations include commitments for advertising and capital expenditures.
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In June 1992, Daleco Capital Corporation formed a limited partnership known as Daleco Zila Partners II, L.P. (the “Partnership”). Zila and its officers have no partnership interest in the Partnership. The purpose of the Partnership was to provide the Company with a means to fund the marketing program for certain products. The original Partnership agreement provided for a minimum of $150,000 and a maximum of $1,562,500 to be raised by the sale of partnership units. Under the original agreement, the Partnership will expend up to 80% of the gross partnership proceeds for marketing and sales-related expenditures on behalf of the Company. In 1994, the Partnership agreement was amended to increase the maximum amount of marketing funds potentially available to the Company to be raised to $2,250,000. At July 31, 2003, approximately $1,820,000 has been spent.
We are committed to pay the Partnership a commission equal to 5% to 10% of the gross sales of certain of the Company’s products, until such time as up to three times the amount of funds expended on the marketing program by the Partnership has been paid to the Partnership. The Company has paid commissions to the Partnership of approximately $1,500, $11,000 and $15,000 for the years ended July 31, 2003, 2002 and 2001, respectively.
We also have approximately $359,000 of ZTC™ , the active ingredient in the OraTest® product, at our manufacturing facility in Phoenix, AZ. We intend to realize the value of this active ingredient through sales in the U.S., once final approval for the OraTest® products are received from the FDA, and in Europe and Asia prior to the date we expect sales in the United States. The drug substance currently has expiration dates in 2004, 2005 and 2006. Previous testing indicates that the drug substance is stable and we expect to be able to extend the expiration dates of the entire drug substance through the date we expect sales in the United States. However, no assurance can be given that such future testing efforts will be successful. In addition, should FDA approval not be granted or be significantly delayed, it may not be possible for us to recover the value of this drug substance.
In December 2002, we transitioned the OraTest® clinical trials to Quintiles. This was the result of an extensive review of several proposals received from some of the largest, highest quality and most prominent CRO’s with worldwide capabilities. Quintiles completed the transition successfully without compromising our current study data. Factors that will affect the cost and timing of completion of the clinical trials include but are not limited to: (i) patient enrollment rates, (ii) tumor formation rate within the study population (iii) compliance with the study protocol and related monitoring, (iv) level of funding throughout the study, and (v) protocol modifications.
We believe that cash generated from our operations, our investing activities and the availability of cash under our line of credit are sufficient to finance our level of operations, the OraTest® clinical trial, anticipated capital expenditures and the stock repurchase program through the next 12 months.
Recent Accounting Pronouncements
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The provisions of SFAS No. 150, which also include a number of new disclosure requirements, are effective for instruments entered into or modified after May 15, 2003 and pre-existing instruments as of the beginning of the first interim period that commences after June 15, 2003. The adoption of SFAS No. 150 did not have a significant effect on our results of operations or financial position.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The amendments set forth in SFAS No. 149 improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. The provisions of SFAS No. 149 are effective for contracts entered into or modified after June 30, 2003. We do not expect the adoption of SFAS No. 149 to have a significant effect on our results of operations or financial position.
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements.” FIN 46 prescribes how to identify variable interest entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. In October 2003, the implementation date of FIN 46 was deferred until the end of the first interim or annual period ending after December 15, 2003. We do not expect the adoption of FIN 46 to have a significant effect on our results of operations or financial position.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 148 provides
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alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We have adopted the disclosure requirements of SFAS No. 148.
In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 sets forth expanded disclosure requirements in the financial statements about a guarantor’s obligations under certain guarantees that it has issued. It also clarifies that, under certain circumstances, a guarantor is required to recognize a liability for the fair value of the obligation at the inception of the guarantee. Certain types of guarantees, such as product warranties, guarantees accounted for as derivatives, and guarantees related to parent-subsidiary relationships are excluded from the liability recognition provisions of FIN 45, however, they are subject to the disclosure requirements. The initial liability recognition provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financial statements for interim or annual periods ending after December 15, 2002. The adoption of FIN 45 did not have an effect on our results of operations or financial position.
In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which replaces EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).” The new standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. The statement is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. We do not expect that the adoption will have a significant impact on our financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” This Statement rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” SFAS No. 44, “Accounting for Intangible Assets of Motor Carriers” and SFAS No. 64, “Extinguishments of Debt Made to Satisfy Sinking Fund Requirements.” This Statement also amends SFAS No. 13, “Accounting for Leases,” to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 was effective for us in the third quarter of fiscal year 2003. The adoption of SFAS No. 145 did not have an effect on our results of operations or financial position.
Effective August 1, 2001, we adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 supercedes existing guidance on asset impairment under SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” Among other provisions, SFAS No. 144 changes the criteria for classifying an asset as held-for-sale. The standard also broadens the scope of businesses to be disposed of that qualify for reporting as discontinued operations, and changes the timing of recognizing losses on such operations. The adoption of SFAS No. 144 did not have a significant impact on our financial position or results of operations. Impairment losses totaled $141,000, $224,000 and $310,000 in 2003, 2002 and 2001, respectively.
In April 2001, the EITF reached consensus on Issue No. 00-25, “Vendor Income Statement Characterization of Consideration from a Vendor to a Retailer.” The Issue discusses accounting and income statement classification of costs, other than those directly addressed in Issue 00-14, that are incurred by a vendor (typically a manufacturer or distributor) to or on behalf of a customer (typically a retailer) in connection with the customer’s purchase or promotion of the vendor’s products. Such costs include consideration given to retailers for space in their stores (slotting fees), consideration given to obtain favorable display positions in the retailer’s stores and other promotional activity such as cooperative advertising. The Issue addresses the recognition and measurement of such costs and whether a vendor should classify such costs in its income statement when incurred as a reduction of revenues or as an expense item. The consensus on EITF No. 00-25 was effective for us on February 1, 2002. The effect of the adoption of EITF No. 00-25 did not have a material impact on our consolidated statement of operations.
In May 2000, the Financial Accounting Standards Board’s Emerging Issues Task Force (“EITF”) reached consensus on Issue No. 00-14, “Accounting for Certain Sales Incentives.” The Issue addresses the recognition, measurement, and income statement classification for certain sales incentives including coupons, rebates and free products. The consensus in Issue No. 00-14 was effective for us on February 1, 2002. The consensus requires certain sales incentives that were previously classified as selling, general and administrative expenses to be classified as a reduction in sales. The cost of free products is now recorded as a reduction of revenues from products sold.
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ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
We are exposed to market risks primarily from interest rates and from changes in foreign currency exchange rates, as well as changes in our credit standing. In addition, a market risk exists associated with the cost of ascorbic acid, a raw material used in our nutraceuticals division. We are assessing strategies to mitigate the risk of increased cost of ascorbic acid through extended-term supply contracts.
We have a revolving line of credit with a variable interest rate equal to three-quarters of one (0.75%) percent per annum in excess of the prime rate announced by First Union Bank (4.75% at July 31, 2003). At July 31, 2003, no borrowings were outstanding under this line of credit. The impact of a 10% proportional increase in average interest rates would not be expected to have a material effect on the Company since average outstanding balances on the line are not expected to be significant. We also have long-term debt associated with the Industrial Development Revenue Bonds that carry a variable interest rate. The rate is set weekly by Bank One Capital Markets and fluctuates based on market conditions and was 1.10% at July 31, 2003. A 10% proportional increase in the average interest rate on the bonds would increase annual interest expense by less than $10,000.
We have certain exposures to foreign currency risk through our subsidiaries that conduct business in Canada and Europe and through a subsidiary that uses the British pound as its functional currency. We believe that such exposure does not present a significant risk due to the limited number of transactions and accounts denominated in foreign currency.
ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
Consolidated financial statements, together with the related notes and the report of Deloitte & Touche LLP, independent certified public accountants, are set forth hereafter. Other required financial information and schedules are set forth herein, as more fully described in Item 15 hereof.
ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
ITEM 9A. | CONTROLS AND PROCEDURES |
The Company’s Chief Executive Officer and Chief Financial Officer, with the participation of the Company’s management, carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer believe that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective in making known to them, recording, processing, summarizing and reporting on a timely basis, material information relating to the Company (including its consolidated subsidiaries) required to be included in this report.
A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected.
During the annual audit, our auditors noted certain weaknesses in general computer controls at our corporate headquarters and Zila Nutraceuticals. In April 2003, we retained a seasoned IT professional as our corporate-wide IT manager to establish common platforms for hardware, software, network management and security across all divisions.
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Our revenue recognition policy is to recognize revenue when the risks and rewards of ownership have transferred to the customer. For certain of our divisions this is considered to have occurred when delivery to the designated location is accomplished such as the customer’s warehouse. In the fiscal year end closing process, we identified and corrected a weakness in the application of this revenue recognition policy at one of our divisions due to reporting revenue for certain customer shipments before they reached their destination. During the annual audit, our auditors indentified further weaknesses related to this revenue recognition policy. To eliminate this issue in the future, we have refined our current period-end revenue cutoff procedures to more specifically factor in the transit time for shipments from Phoenix to all destination points within the United States, thereby avoiding the problem of recognizing revenue on shipments that are still in transit at period-end.
Other than the above issues, there were no changes in the Company’s internal control over financial reporting, known to the Chief Executive Officer or the Chief Financial Officer, that occurred during the quarter ended July 31, 2003 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART III
The information called for by this Part III is, in accordance with General Instruction G (3) to Form 10-K, incorporated herein by reference to the information contained in our definitive proxy statement for the annual meeting of stockholders of Zila to be held on December 4, 2003, which will be filed with the SEC not later than 120 days after July 31, 2003.
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PART IV
ITEM 15. | EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES, AND REPORTS ON FORM 8-K |
| | | Method of Filing |
(a) | Financial Statements | |
| (1) | Report of Deloitte & Touche LLP | Filed herewith |
| (2) | Consolidated Financial Statements and Notes thereto of the Company including | Filed herewith |
| | Consolidated Balance Sheets as of July 31, 2003 and 2002 and related | |
| | Consolidated Statements of Operations, Comprehensive Income (Loss), Shareholders’ Equity, and Cash Flows for each of the years in the three-year period ended July 31, 2003 | |
| (3) | Financial Statement Schedule II Valuation and Qualifying Accounts | Filed herewith |
| | |
(b) | Reports on Form 8-K for the quarter ended July 31, 2003. | |
| | |
| During the quarter ended July 31, 2003, we filed four Current Reports on Form 8-K dated May 5, June 16, June 30 and July 30, 2003. The June 30, 2003 Current Report on Form 8-K contained information regarding our $20 million settlement with our former CRO. |
(c) Exhibits.
Exhibit Number | | Description | | Method of Filing |
| |
| |
|
3-A | | Certificate of Incorporation, as amended | | A |
3-B | | Amended and Restated Bylaws (as amended through September 26, 2002) | | O |
3-C | | Certificate of Designations, Preferences and Rights of Series A Convertible Preferred Stock | | C |
3-D | | Certificate of Designations, Preferences and Rights of Series B Convertible Preferred Stock | | L |
4-A | | Specimen Stock Certificate | | A |
10-A | | Revolving Line of Credit Loan Agreement dated February 1, 1999 between Zila, Inc. and Bank One, Arizona | | A |
10-B | | Stock Option Award Plan (as amended through April 10, 1991) | | B |
10-C | | Non-Employee Directors Stock Option Plan (as amended through September 26, 2002) | | R |
10-L | | Asset Purchase Agreement dated October 28, 1999 between Zila, Inc., and Cygnus Imaging, Inc. and Procare Laboratories, Inc. | | A |
10-M | | Secured Note dated October 28, 1999 between Zila, Inc. and Procare Laboratories, Inc. | | A |
10-N | | Asset Purchase agreement dated as of November 30, 1999 by and among Zila, Inc., Integrated Dental Technologies, Inc., InfoCure Systems, Inc., and InfoCure Corporation | | E |
10-O | | Revolving Line of Credit Loan Agreement dated December 1, 2000 between Zila, Inc. and Bank One, Arizona, NA | | H |
10-P | | First Loan Modification Agreement dated May 7, 2001 between Zila, Inc. and Bank One Arizona, NA | | H |
10-Q | | Engagement Letter dated March 15, 2001 between Zila, Inc. and Douglas, Curtis and Allyn, LLC | | H |
10-R | | Extension to First Loan Modification Agreement dated effective May 31, 2001 between Zila, Inc. and Bank One Arizona, NA | | H |
10-S | | Second Extension to First Loan Modification Agreement dated effective June 29, 2001 between Zila, | | |
| | Inc. and Bank One Arizona, NA | | I |
10-T | | Third Extension to First Loan Modification Agreement dated effective July 31, 2001 between Zila, Inc. and Bank One Arizona, NA | | J |
10-U | | 1997 Stock Option Award Plan (as amended through September 13, 2001) | | G |
10-V | | Employee Stock Purchase Plan | | F |
10-W | | Loan and Security Agreement dated August 17, 2001 by and between Congress Financial Corporation and Zila, Inc., Zila Pharmaceuticals, Inc. Ryker Dental of Kentucky, Inc. and Inter-Cal Corporation, Inc | | K |
10-X | | Asset Purchase Agreement, dated as of November 1, 2001, by and between Ryker Dental of Kentucky, Inc. and Henry Schein, Inc | | M |
10-Y | | Amended and Restated Asset Purchase Agreement dated as of December 4, 2001 by and among Zila, Inc., Ryker Dental of Kentucky, Inc. and PracticeWares, Inc | | M |
10-Z | | First Amendment to Engagement Letter dated as of June 6, 2002 between Zila, Inc. and Douglas, Curtis & Allyn, LLC | | N |
10-Aa | | Fourth Extension and Modification Agreement dated as of June 6, 2002 between Ryker Dental of Kentucky, Inc., PracticeWares, Inc. and PracticeWorks, Inc. and Gregory A. Jones | | N |
10-Ab | | First Amendment to Amended and Restated Asset Purchase Agreement dated as of June 18, 2002 between Ryker Dental of Kentucky, Inc., PracticeWares, Inc. and Zila, Inc | | N |
10-Ac | | Stockholders Agreement dated as of June 18, 2002, among PracticeWorks, Inc., Gregory A. Jones, Ryker Dental of Kentucky, Inc. and PracticeWares, Inc | | N |
10-Ad | | Third Amendment dated December 13, 2002 to the Loan and Security Agreement dated August 17, 2001 by and between Congress Financial Corporation and Zila, Inc., Zila Pharmaceuticals, Inc., Ryker Dental of Kentucky, Inc., and Inter-Cal Corporation | | P |
10-Ae | | General Services Agreement between Zila, Inc. and Quintiles, Inc. dated December 18, 2002 (without exhibits) | | Q |
10-Af | | Investment Agreeement between Zila, Inc. and PharmaBio Development, Inc. dated December 18, 2002 | | Q |
10-Ag | | Offer letter between Zila, Inc. and Lawrence J. Batina dated January 27, 2003 | | Q |
- 36 -
Exhibit Number | | Description | | Method of Filing |
| |
| |
|
10-Ah | | Fourth Amendment dated January 31, 2003 to the Loan and Security Agreement dated August 17, 2001 by and between Congress Financial Corporation and Zila, Inc., Zila Pharmaceuticals, Inc., Ryker Dental of Kentucky, Inc., and Inter-Cal Corporation | | Q |
21 | | Subsidiaries of Registrant | | D |
23 | | Consent of Deloitte & Touche LLP (regarding Form S-8 and Form S-3 Registration Statements) | | * |
24-A | | Power of Attorney of Lawrence J. Batina | | * |
24-B | | Power of Attorney of Douglas D. Burkett | | * |
24-C | | Power of Attorney of Michael S. Lesser | | * |
24-D | | Power of Attorney of Christopher D. Johnson | | * |
24-E | | Power of Attorney of Kevin J. Tourek | | * |
24-F | | Power of Attorney of Timothy Rose | | * |
24-G | | Power of Attorney of John Edward Porter | | * |
24-H | | Power of Attorney of Morris C. Aaron | | * |
31.1 | | Sarbanes-Oxley Section 302 Certification of the Chief Executive Officer | | * |
31.2 | | Sarbanes-Oxley Section 302 Certification of the Chief Financial Officer | | * |
32.1 | | Sarbanes-Oxley Section 906 Certification of the Chief Executive Officer | | * |
32.2 | | Sarbanes-Oxley Section 906 Certification of the Chief Financial Officer | | * |
* | Filed herewith |
A | Incorporated by reference to the Company’s Annual Report on Form 10-K for fiscal year ended July 31, 1999 |
B | Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended January 31, 1996, as amended |
C | Incorporated by reference to the Company’s Annual Report on Form 10-K for fiscal year ended July 31, 1997 |
D | Incorporated by reference to the Company’s Annual Report on Form 10-K for fiscal year ended July 31, 1998 |
E | Incorporated by reference to the Company’s Current Report on Form 8-K dated January 3, 2000 |
F | Incorporated by reference to the Company’s Form S-8 Registration Statement No. 333-54958 dated February 5, 2001 |
G | Incorporated by reference to the Company’s Form S-8 Registration Statement No. 333-54960 dated February 5, 2001 |
H | Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended April 30, 2001 |
I | Incorporated by reference to the Company’s Current Report on Form 8-K dated June 29, 2001 |
J | Incorporated by reference to the Company’s Current Report on Form 8-K dated July 31, 2001 |
K | Incorporated by reference to the Company’s Current Report on Form 8-K dated August 17, 2001 |
L | Incorporated by reference to the Company’s Annual Report on Form 10-K for fiscal year ended July 31, 2001. |
M | Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended October 31, 2001 |
N | Incorporated by reference to the Company’s Current Report on Form 8-K dated June 18, 2002 2003 located on signature page |
O | Incorporated by reference to the Company’s Annual Report on Form 10-K for fiscal year ended July 31, 2003 |
P | Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended October 31, 2002 |
Q | Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended January 31, 2003 |
R | Incorporated by reference to the Company’s Proxy Statement on Schedule 14-A dated January 14, 2003 |
- 37 -
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, this 27th day of October, 2003.
| ZILA, INC., a Delaware corporation |
| |
| By | /s/ LAWRENCE J. BATINA |
|
|
| | Lawrence J. Batina |
| | Vice President and Chief Financial Officer |
| | (Principal Financial and Accounting Officer) |
| | | |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
Signature | | Title | | Date |
| |
| |
|
| | | | |
/s/ DOUGLAS D. BURKETT, PH.D. | | Chairman of the Board, | | |
| | President, Chief Executive Officer | | |
Douglas D. Burkett Ph.D. | | | | October 27, 2003 |
| | | | |
* | | | | |
| | | | |
Michael S. Lesser | | Director | | October 27, 2003 |
| | | | |
* | | | | |
| | | | |
Christopher D. Johnson | | Director | | October 27, 2003 |
| | | | |
* | | | | |
| | | | |
Kevin J. Tourek | | Director | | October 27, 2003 |
| | | | |
* | | | | |
| | | | |
S. Timothy Rose | | Director | | October 27, 2003 |
| | | | |
* | | | | |
| | | | |
John Edward Porter | | Director | | October 27, 2003 |
| | | | |
* | | | | |
| | | | |
Morris C. Aaron | | Director | | October 27, 2003 |
| | | | |
* By /s/ LAWRENCE J. BATINA * | | | | |
| | | | October 27, 2003 |
Lawrence J. Batina | | | | |
Attorney-in Fact | | | | |
- 38 -
INDEPENDENT AUDITORS’ REPORT
Board of Directors and Shareholders
Zila, Inc.
Phoenix, Arizona
We have audited the accompanying consolidated balance sheets of Zila, Inc. and subsidiaries as of July 31, 2003 and 2002, and the related consolidated statements of operations, comprehensive income (loss), shareholders’ equity, and cash flows for each of the three years in the period ended July 31, 2003. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(3). These financial statements and financial statement schedule are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Zila, Inc. and subsidiaries as of July 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 2003 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 7 to the consolidated financial statements, in 2003 the Company changed its method of accounting for goodwill and other intangible assets to conform to Statement of Financial Accounting Standards No. 142.
DELOITTE & TOUCHE LLP
Phoenix, Arizona
October 26, 2003
F-1
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JULY 31, 2003 AND 2002
| | 2003 | | 2002 | |
| |
|
| |
|
| |
ASSETS | | | | | | | |
CURRENT ASSETS: | | | | | | | |
Cash and cash equivalents | | $ | 16,160,484 | | $ | 1,604,205 | |
Trade receivables, less allowance for doubtful accounts of $317,215 (2003) and $132,619 (2002) | | | 7,550,735 | | | 5,694,856 | |
Inventories – net | | | 8,088,222 | | | 8,868,539 | |
Prepaid expenses and other current assets | | | 1,760,710 | | | 2,085,137 | |
| |
|
| |
|
| |
Total current assets | | | 33,560,151 | | | 18,252,737 | |
| |
|
| |
|
| |
PROPERTY AND EQUIPMENT - net | | | 9,481,307 | | | 8,848,299 | |
PURCHASED TECHNOLOGY RIGHTS - net | | | 3,988,964 | | | 4,467,579 | |
GOODWILL - net | | | 6,930,192 | | | 11,014,385 | |
TRADEMARKS AND OTHER INTANGIBLE ASSETS - net | | | 13,720,022 | | | 14,356,652 | |
OTHER ASSETS | | | 1,339,680 | | | 421,001 | |
| |
|
| |
|
| |
TOTAL | | $ | 69,020,316 | | $ | 57,360,653 | |
| |
|
| |
|
| |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | |
CURRENT LIABILITIES: | | | | | | | |
Accounts payable | | $ | 7,399,416 | | $ | 3,249,649 | |
Accrued liabilities | | | 3,502,405 | | | 3,588,627 | |
Short-term borrowings | | | 154,793 | | | 99,784 | |
Current portion of long-term debt | | | 487,449 | | | 489,161 | |
| |
|
| |
|
| |
Total current liabilities | | | 11,544,063 | | | 7,427,221 | |
LONG-TERM DEBT - net of current portion | | | 3,728,126 | | | 3,610,483 | |
| |
|
| |
|
| |
Total liabilities | | | 15,272,189 | | | 11,037,704 | |
| |
|
| |
|
| |
COMMITMENTS AND CONTINGENCIES (Note 13) | | | | | | | |
SHAREHOLDERS’ EQUITY: | | | | | | | |
Preferred stock - Series B, $.001 par value – authorized 2,500,000 shares, issued 100,000 shares | | | 462,500 | | | 462,500 | |
Common stock, $.001 par value - authorized 65,000,000 shares, issued 45,814,893 shares (July 31, 2003) and 45,666,160 shares (July 31, 2002) | | | 45,815 | | | 45,666 | |
Capital in excess of par value | | | 83,115,158 | | | 82,899,967 | |
Accumulated other comprehensive loss | | | (75,644 | ) | | (75,376 | ) |
Accumulated deficit | | | (29,228,329 | ) | | (36,474,688 | ) |
Common stock in treasury, at cost, 225,100 shares (July 31, 2003) and 195,000 shares (July 31, 2002) | | | (571,373 | ) | | (535,120 | ) |
| |
|
| |
|
| |
Total shareholders’ equity | | | 53,748,127 | | | 46,322,949 | |
| |
|
| |
|
| |
TOTAL | | $ | 69,020,316 | | $ | 57,360,653 | |
| |
|
| |
|
| |
See notes to consolidated financial statements.
F-2
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JULY 31, 2003, 2002 and 2001
| | 2003 | | 2002 | | 2001 | |
| |
|
| |
|
| |
|
| |
NET REVENUES | | $ | 47,106,865 | | $ | 34,871,770 | | $ | 30,710,761 | |
OPERATING COSTS AND EXPENSES: | | | | | | | | | | |
Cost of products sold (exclusive of depreciation shown separately below) | | | 20,209,144 | | | 12,464,081 | | | 10,273,533 | |
Marketing and selling | | | 9,851,918 | | | 10,185,522 | | | 9,227,001 | |
General and administrative | | | 12,692,172 | | | 11,657,878 | | | 10,762,597 | |
Severance and related charges | | | 1,322,147 | | | | | | | |
Research and development | | | 3,832,510 | | | 3,955,790 | | | 3,036,896 | |
Impairment of assets | | | 140,794 | | | 224,347 | | | 310,000 | |
Depreciation and amortization | | | 2,432,449 | | | 3,468,041 | | | 3,174,566 | |
| |
|
| |
|
| |
|
| |
| | | 50,481,134 | | | 41,955,659 | | | 36,784,593 | |
| |
|
| |
|
| |
|
| |
LOSS FROM OPERATIONS | | | (3,374,269 | ) | | (7,083,889 | ) | | (6,073,832 | ) |
| |
|
| |
|
| |
|
| |
OTHER INCOME (EXPENSE): | | | | | | | | | | |
Interest income | | | 15,132 | | | 68,959 | | | 181,669 | |
Interest expense | | | (373,764 | ) | | (486,939 | ) | | (596,870 | ) |
Contract settlement gain, net of related expenses | | | 14,844,093 | | | | | | | |
Gain on sale of assets | | | 530,756 | | | | | | | |
Other income (expense) | | | (94,270 | ) | | 117,908 | | | (159,051 | ) |
| |
|
| |
|
| |
|
| |
| | | 14,921,947 | | | (300,072 | ) | | (574,252 | ) |
| |
|
| |
|
| |
|
| |
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND ACCOUNTING CHANGE | | | 11,547,678 | | | (7,383,961 | ) | | (6,648,084 | ) |
INCOME TAX (EXPENSE) BENEFIT | | | (188,126 | ) | | (3,954,319 | ) | | 378,786 | |
| |
|
| |
|
| |
|
| |
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE ACCOUNTING CHANGE | | | 11,359,552 | | | (11,338,280 | ) | | (6,269,298 | ) |
| |
|
| |
|
| |
|
| |
DISCONTINUED OPERATIONS: | | | | | | | | | | |
Loss from operations of discontinued Dental Supply segment, net of income taxes of $0 (2003), $0 (2002) and $7,326 (2001) | | | | | | (815,460 | ) | | (121,194 | ) |
Net gain from disposal of Dental Supply segment | | | 10,000 | | | 143,456 | | | | |
| |
|
| |
|
| |
|
| |
Total gain (loss) from discontinued operations | | | 10,000 | | | (672,004 | ) | | (121,194 | ) |
| |
|
| |
|
| |
|
| |
INCOME (LOSS) BEFORE ACCOUNTING CHANGE | | | 11,369,552 | | | (12,010,284 | ) | | (6,390,492 | ) |
Cumulative effect of accounting change | | | (4,084,193 | ) | | | | | | |
| |
|
| |
|
| |
|
| |
NET INCOME (LOSS) | | | 7,285,359 | | | (12,010,284 | ) | | (6,390,492 | ) |
Preferred stock dividends | | | 39,000 | | | 58,500 | | | | |
| |
|
| |
|
| |
|
| |
Net income (loss) attributable to common shareholders | | $ | 7,246,359 | | $ | (12,068,784 | ) | $ | (6,390,492 | ) |
| |
|
| |
|
| |
|
| |
BASIC NET INCOME (LOSS) PER COMMON SHARE: | | | | | | | | | | |
Income (loss) from continuing operations | | $ | 0.25 | | $ | (0.25 | ) | $ | (0.15 | ) |
Income (loss) from discontinued operations | | | 0.00 | | | (0.02 | ) | | 0.00 | |
Change in accounting principle | | | (0.09 | ) | | 0.00 | | | 0.00 | |
| |
|
| |
|
| |
|
| |
NET INCOME (LOSS) | | $ | 0.16 | | $ | (0.27 | ) | $ | (0.15 | ) |
| |
|
| |
|
| |
|
| |
Weighted average shares outstanding | | | 45,490,111 | | | 44,592,932 | | | 43,412,786 | |
| |
|
| |
|
| |
|
| |
DILUTED NET INCOME (LOSS) PER COMMON SHARE: | | | | | | | | | | |
Income (loss) from continuing operations | | $ | 0.25 | | $ | (0.25 | ) | $ | (0.15 | ) |
Income (loss) from discontinued operations | | | 0.00 | | | (0.02 | ) | | — | |
Change in accounting principle, net of tax | | | (0.09 | ) | | 0.00 | | | 0.00 | |
| |
|
| |
|
| |
|
| |
NET INCOME (LOSS) | | $ | 0.16 | | $ | (0.27 | ) | $ | (0.15 | ) |
| |
|
| |
|
| |
|
| |
Weighted average shares outstanding | | | 45,765,939 | | | 44,592,932 | | | 43,412,786 | |
| |
|
| |
|
| |
|
| |
See notes to consolidated financial statements.
F-3
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
YEARS ENDED July 31, 2003, 2002 and 2001
| | 2003 | | 2002 | | 2001 | |
| |
|
| |
|
| |
|
| |
Net income (loss) | | $ | 7,285,359 | | $ | (12,010,284 | ) | $ | (6,390,492 | ) |
| |
|
| |
|
| |
|
| |
Other comprehensive income (loss), net of tax: | | | | | | | | | | |
Foreign currency translation adjustment | | | (268 | ) | | (226,352 | ) | | 75,810 | |
Reclassification of holding losses included in net loss | | | | | | | | | 3,500 | |
| |
|
| |
|
| |
|
| |
Other comprehensive income (loss) | | | (268 | ) | | (226,352 | ) | | 79,310 | |
Comprehensive income (loss) | | $ | 7,285,091 | | $ | (12,236,636 | ) | $ | (6,311,182 | ) |
| |
|
| |
|
| |
|
| |
| | Foreign
Currency Adjustments | | Accumulated
Other Comprehensive Income | |
| |
|
| |
|
| |
Balance at July 31, 2001 | | $ | 150,976 | | $ | 150,976 | |
Other comprehensive income | | | (226,352 | ) | | (226,352 | ) |
| |
|
| |
|
| |
Balance at July 31, 2002 | | | (75,376 | ) | | (75,376 | ) |
Other comprehensive loss | | | (268 | ) | | (268 | ) |
| |
|
| |
|
| |
Balance at July 31, 2003 | | $ | (75,644 | ) | $ | (75,644 | ) |
| |
|
| |
|
| |
See notes to consolidated financial statements.
F-4
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
YEARS ENDED JULY 31, 2003, 2002 AND 2001
| | | | | | | | Shareholders’ Equity | |
| | | | | | | |
| |
| | Preferred Stock | | Common Stock | | | | | | | | | | | | | | | | |
| |
| |
| | Capital in Excess of Par Value | | Accumulated
Deficit | | Treasury Stock | | Accumulated Other Comprehensive Income (Loss) | | Total Shareholders’ Equity | |
| | Shares | | Amount | | Shares | | Par
Value | | | | | | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
BALANCE, JULY 31, 2000 | | | | | | | | | 43,362,658 | | | 43,363 | | | 79,424,235 | | | (18,015,412 | ) | | (409,750 | ) | | 71,666 | | | 61,114,102 | |
Warrants issued for services provided | | | | | | | | | | | | | | | 30,000 | | | | | | | | | | | | 30,000 | |
Purchase of common stock for treasury | | | | | | | | | | | | | | | | | | | | | (125,370 | ) | | | | | (125,370 | ) |
Exercise of common stock warrants | | | | | | | | | 149,870 | | | 150 | | | 449,460 | | | | | | | | | | | | 449,610 | |
Exercise of common stock options | | | | | | | | | 128,622 | | | 129 | | | 2,871 | | | | | | | | | | | | 3,000 | |
Issuance of common stock | | | | | | | | | 12,577 | | | 12 | | | 23,528 | | | | | | | | | | | | 23,540 | |
Issuance of preferred stock | | | 100,000 | | | 462,500 | | | | | | | | | | | | | | | | | | | | | 462,500 | |
Foreign currency translation | | | | | | | | | | | | | | | | | | | | | | | | 75,810 | | | 75,810 | |
Net unrealized gain on available-for-sale securities | | | | | | | | | | | | | | | | | | | | | | | | 3,500 | | | 3,500 | |
Net loss | | | | | | | | | | | | | | | | | | (6,390,492 | ) | | | | | | | | (6,390,492 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
BALANCE, JULY 31, 2001 | | | 100,000 | | $ | 462,500 | | | 43,653,727 | | $ | 43,654 | | $ | 79,930,094 | | $ | (24,405,904 | ) | $ | (535,120 | ) | $ | 150,976 | | $ | 55,646,200 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Dividends on preferred stock | | | | | | | | | | | | | | | | | | (58,500 | ) | | | | | | | | (58,500 | ) |
Issuance of common stock | | | | | | | | | 2,012,433 | | | 2,012 | | | 2,969,873 | | | | | | | | | | | | 2,971,885 | |
Foreign currency translation | | | | | | | | | | | | | | | | | | | | | | | | (226,352 | ) | | (226,352 | ) |
Net loss | | | | | | | | | | | | | | | | | | (12,010,284 | ) | | | | | | | | (12,010,284 | ) |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
BALANCE, JULY 31, 2002 | | | 100,000 | | $ | 462,500 | | | 45,666,160 | | $ | 45,666 | | $ | 82,899,967 | | $ | (36,474,688 | ) | $ | (535,120 | ) | $ | (75,376 | ) | $ | 46,322,949 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Warrants issued for services provided | | | | | | | | | | | | | | | 70,569 | | | | | | | | | | | | 70,569 | |
Dividends on preferred stock | | | | | | | | | | | | | | | | | | (39,000 | ) | | | | | | | | (39,000 | ) |
Purchase of common stock for treasury | | | | | | | | | | | | | | | | | | | | | (36,253 | ) | | | | | (36,253 | ) |
Exercise of common stock warrants | | | | | | | | | 5,000 | | | 5 | | | 5,245 | | | | | | | | | | | | 5,250 | |
Issuance of common stock | | | | | | | | | 143,733 | | | 144 | | | 139,377 | | | | | | | | | | | | 139,521 | |
Foreign currency translation | | | | | | | | | | | | | | | | | | | | | | | | (268 | ) | | (268 | ) |
Net income | | | | | | | | | | | | | | | | | | 7,285,359 | | | | | | | | | 7,285,359 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
BALANCE, JULY 31, 2003 | | | 100,000 | | $ | 462,500 | | | 45,814,893 | | $ | 45,815 | | $ | 83,115,158 | | $ | (29,228,329 | ) | $ | (571,373 | ) | $ | (75,644 | ) | $ | 53,748,127 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
See notes to consolidated financial statements.
F-5
ZILA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JULY 31, 2003, 2002, 2001
| | 2003 | | 2002 | | 2001 | |
| |
|
| |
|
| |
|
| |
OPERATING ACTIVITIES: | | | | | | | | | | |
Net income (loss) | | $ | 7,285,359 | | $ | (12,010,284 | ) | $ | (6,390,492 | ) |
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | | | | | | | | | | |
Depreciation and amortization | | | 2,432,449 | | | 3,468,041 | | | 3,174,566 | |
Effect of change in accounting principle | | | 4,084,193 | | | | | | | |
Gain on sale of assets | | | (530,756 | ) | | | | | (17,116 | ) |
Loss (gain) from discontinued operations | | | (10,000 | ) | | 672,004 | | | 121,194 | |
Impairment of assets | | | 140,794 | | | 224,347 | | | 310,000 | |
Warrants issued for services | | | 70,569 | | | | | | 30,000 | |
Deferred income taxes and other | | | (11,717 | ) | | 4,303,550 | | | (253,851 | ) |
Change in assets and liabilities: | | | | | | | | | | |
Receivables - net | | | (1,855,879 | ) | | 968,464 | | | (229,144 | ) |
Inventories | | | 780,317 | | | 2,233,358 | | | (4,243,438 | ) |
Prepaid expenses and other assets | | | (594,252 | ) | | (261,925 | ) | | 153,370 | |
Accounts payable and accrued liabilities | | | 4,073,538 | | | 1,562,465 | | | (1,276,370 | ) |
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Net cash provided by (used in) operating activities | | | 15,864,615 | | | 1,160,020 | | | (8,621,281 | ) |
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INVESTING ACTIVITIES: | | | | | | | | | | |
Purchases of property and equipment | | | (1,884,926 | ) | | (619,168 | ) | | (2,323,601 | ) |
Net proceeds from sale of assets | | | 531,966 | | | | | | 1,030,662 | |
Retained liabilities of discontinued operations | | | | | | (2,080,352 | ) | | (231,846 | ) |
Net cash paid for acquisition | | | | | | | | | (1,849,418 | ) |
Net proceeds from disposition of discontinued operations | | | 10,000 | | | 9,719,125 | | | | |
Purchases of intangible assets | | | (195,815 | ) | | (1,047,082 | ) | | (833,843 | ) |
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Net cash provided by (used in) investing activities | | | (1,538,775 | ) | | 5,972,550 | | | (4,208,046 | ) |
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FINANCING ACTIVITIES: | | | | | | | | | | |
Net (repayments) proceeds from short-term borrowings | | | 55,009 | | | (6,061,163 | ) | | 6,109,177 | |
Proceeds from issuance of common stock | | | 144,752 | | | 25,363 | | | 476,150 | |
Acquisition of treasury stock | | | (36,253 | ) | | | | | (125,370 | ) |
Dividends paid to preferred stockholders | | | (49,000 | ) | | (29,000 | ) | | | |
Cash released by trustee | | | | | | | | | 2,928,001 | |
Proceeds from long-term borrowings | | | 641,515 | | | | | | | |
Principal payments on long-term debt | | | (525,584 | ) | | (727,500 | ) | | (486,947 | ) |
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Net cash provided by (used in) financing activities | | | 230,439 | | | (6,792,300 | ) | | 8,901,101 | |
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NET INCREASE (DECREASE) IN CASH AND CASH EQUIVILENTS | | | 14,556,279 | | | 340,270 | | | (3,928,316 | ) |
CASH AND CASH EQUIVILENTS,BEGINNING OF YEAR | | | 1,604,205 | | | 1,263,935 | | | 5,192,251 | |
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CASH AND CASH EQUIVILENTS, END OF YEAR | | $ | 16,160,484 | | $ | 1,604,205 | | $ | 1,263,935 | |
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CASH PAID FOR INTEREST | | $ | 197,067 | | $ | 415,832 | | $ | 498,556 | |
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CASH PAID FOR INCOME TAXES | | $ | | | $ | 17,051 | | $ | 94,521 | |
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SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES | | | | | | | | | | |
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Issuance of common stock related to ViziLite in exchange for license and research and development | | | | | $ | 2,946,522 | | | | |
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| | | | |
Issuance of Series B Convertible Preferred Stock for acquisition | | | | | | | | $ | 462,500 | |
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See notes to consolidated financial statements.
F-6
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended July 31, 2003, 2002 and 2001
1. Nature of Business Activities and Summary of Significant Accounting Policies
Nature of Business Activities
Zila, Inc. and subsidiaries (“Zila”), a Delaware corporation, is an innovator in preventative healthcare technologies and products, focusing on enhanced body defense and the detection of pre-disease states. In fiscal year 2003, our business was reorganized into the following Groups: Nutraceuticals, Pharmaceuticals and Biotechnology. The Nutraceuticals Group is comprised of Oxycal Laboratories, Inc. (“Oxycal”) and its subsidiary, Zila Nutraceuticals, Inc., a manufacturer and marketer of patented Ester-C®, a branded, highly effective form of vitamin C sold in 41 countries worldwide and distributes the Palmettx® line of botanical products. The Zila Pharmaceuticals Group includes Zila Pharmaceuticals, Inc. and the Zilactin® family of products, Peridex® prescription mouth rinse, the ViziLite® chemiluminescent light for illumination of oral mucosal abnormalities and the plastic molded products of Zila Swab Technologies, Inc., dba Innovative Swab Technologies (“IST”). The Zila Biotechnology Group is the research, development and licensing business specializing in pre-cancer/cancer detection through its patented Zila® Tolonium Chloride and OraTest® technologies and now manages the OraTest® product, an oral cancer diagnostic system, which is currently in Food and Drug Administration (“FDA”) phase III clinical trials.
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“generally accepted accounting principles”).
Certain reclasses have been made to the prior year to conform with the current year presentation.
Summary of Significant Accounting Policies
Principles of Consolidation - The consolidated financial statements include the accounts of Zila, Inc. and its wholly owned subsidiaries, Zila Pharmaceuticals, Inc., Zila International Inc., Zila Biotechnology, Inc., Zila Ltd., Bio-Dental Technologies Corporation (“Bio-Dental”), Zila Technologies, Inc, Zila Swab Technologies, Inc., dba Innovative Swab Technologies (“IST”), Zila Acquisition, Inc. and Oxycal Laboratories, Inc. Zila International Inc. and Zila Acquisition, Inc. have no operations. All significant intercompany balances and transactions are eliminated in consolidation.
Use of Estimates and Risks and Uncertainties - The preparation of financial statements in conformity with generally accepted accounting principles necessarily requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates based upon future events, which could include, among other risks, changes in the regulations governing the manner in which we sell our products, changes in the health care environment, and reliance on contract manufacturing services. Significant use of estimates include cash flows used to measure long-lived assets related to the OraTest® and ViziLite® products, assumptions regarding the fair value of goodwill and other intangibles, calculations for accounts receivable and inventory reserves and accruals for legal matters.
In our Biotechnology Group, the cash flows used to measure long-lived assets related to the OraTest® product are dependent upon obtaining FDA approval and generating sufficient revenues from sales of the OraTest® product. The rigorous clinical testing and an extensive regulatory approval process mandated by the FDA and equivalent foreign authorities before any new drug can be marketed can take a number of years and require the expenditure of substantial resources. We anticipate that the net proceeds of approximately $14.8 million received from the settlement of the contract dispute with our former contract research organization, (“CRO”), along with cash generated from our Nutraceuticals and Pharmaceuticals groups, will be adequate to support these activities. However, obtaining such approvals and completing such testing is a costly and time-consuming process, and approval may not be ultimately obtained. The length of the FDA review period varies considerably, as does the amount of clinical data required to demonstrate the safety and efficacy of a specific product. Net long-lived assets related to the OraTest® product as of July 31, 2003 of $6.7 million have been capitalized.
F-7
Concentration of Sales to Significant Customers - For each of the last three fiscal years, there have been sales to three significant customers. Sales to these significant customers as a percent of Net Revenues were 25.2%, 23.1% and 19.5% in fiscal years 2003, 2002 and 2001, respectively. One customer ranked among the top three customers for all three years. Two other customers ranked among the top three customers in two of the three years.
Revenue Recognition - Revenue from sales of products is recognized when earned; that is, when the risks and rewards of ownership have transferred to the customer. Cash discounts, sales incentives, and returns are estimated and recognized at the date of shipment based upon historical activity and current customer commitments. We evaluate these estimates on a quarterly basis and revise them as necessary.
On occasion, we enter into arrangements to license our technology on specifically approved products. For those arrangements where we have continuing involvement with the licensee, nonrefundable, upfront license fees are recognized systematically as they are earned over the life of the agreement. Fees associated with substantive, at risk, performance milestones are recognized as revenue as the milestones are achieved, as defined in the respective agreements. For perpetual licenses or manufacturing rights agreements, where (i) we have no further continuing involvement with the licensee; (ii) the fees are nonrefundable; and (iii) the fees are not a prepayment of future royalties, the fees are recognized as revenue at the time the arrangement becomes effective.
Cash Equivalents – Cash equivalents include highly liquid investments purchased with remaining maturities of three months or less.
Inventories consist of finished goods, work in process and raw materials and are stated at the lower of cost (first-in, first-out method) or market.
Property and Equipment are stated at cost and are depreciated using the straight-line method over their respective estimated useful lives, ranging from 2 to 40 years. Leasehold improvements are depreciated over the lease term or the estimated useful life, whichever is shorter. Listed below are the ranges of useful lives by property and equipment category:
Building | 20-40 years |
Building improvements | 10 years |
Furniture and equipment | 5 years |
Production and warehouse equipment | 7-10 years |
Intangible Assets – As of August 1, 2002, we adopted of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” Under the requirements of this SFAS, goodwill is no longer amortized but rather tested periodically for impairment using a fair value approach at the reporting unit level. A reporting unit is the operating segment, or a business one level below the operating segment (“component” level) if discrete financial information is prepared and regularly reviewed by management at the component level. An impairment charge is recognized for any amount by which the carrying amount of a reporting unit’s goodwill exceeds it fair value. We use discounted cash flows to establish fair values. Our policy is to test goodwill for impairment annually as of April 30, the end of our third fiscal quarter. (See Note 7 for additional discussion.)
We amortize the cost of other intangibles over their estimated useful lives unless such lives are deemed indefinite. We continually evaluate the reasonableness of the estimated useful lives of amortizable intangibles.
Our policy is to review the carrying amounts of intangible assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Such events or circumstances might include a significant decline in market share, a significant decline in profits, rapid changes in technology, significant litigation or other items. In evaluating the recoverability of other intangible assets, our policy is to compare the carrying amounts of such assets with the estimated undiscounted future operating cash flows. In the event impairment exists, an impairment charge would be determined by comparing the carrying amounts of the asset to the applicable estimated future cash flows, discounted at a risk-adjusted rate. In addition, the remaining amortization period for the impaired asset would be reassessed and revised if necessary.
F-8
Significant components of intangible assets are as follows:
| Purchased Technology Rights - In 1996, we acquired CTM Associates, Inc. ("CTM"). The purchase of CTM perfected our interest in the OraTest® technology and eliminated our obligation to pay royalties to CTM on future sales of the OraTest® product. The recoverability of the $4 million net purchased technology rights is dependent upon obtaining FDA approval and generating sufficient revenues from future sales of the OraTest® products. (see Note 13). Fixed assets of approximately $846,000 (primarily related to a manufacturing facility), patents and patents pending of $1,057,000, long-term assets of $1,119,000 and inventory of $219,000 are also associated with the OraTest® products and are grouped with the purchased technology rights for the purpose of testing recoverability. The purchased technology rights are amortized on a straight-line basis over the expected period of benefit, which was based on the estimated remaining life of the related patents, which will expire in 2011. |
|
Peridex Goodwill – Goodwill totaling approximately $4 million (net of accumulated amortization of $4.6 million) related to the Peridex® product which was acquired from The Procter & Gamble Company in November 1997. |
|
Zila Nutraceuticals- Goodwill and trademarks totaling approximately $11.8 million (net of accumulated amortization of $3.5 million) are related to the Ester-C® group of products. These assets were acquired by merger in 1997 and are combined for purposes of testing for impairment. We forecast that cash flows associated with the Ester-C® products will allow recovery of the total intangible asset balance in approximately 5 years if net cash flows continue at current levels.
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|
Trademarks and Other Intangible Assets - Trademarks are amortized on a straight-line basis over the lesser of their legal or expected lives, which range from 17 to 25 years. Other intangible assets include deferred patent costs, which represent legal costs associated with filing patent applications, and licensing costs related to the ViziLite product. Other intangible assets are amortized on a straight-line basis over the lesser of their legal or expected lives, which range from 10 to 17 years. |
Research and Development - The costs associated with research and development programs for new products and significant product improvements are expensed as incurred. Research and development costs totaled $3,833,000, $3,956,000, and $3,037,000 in 2003, 2002 and 2001, respectively.
Net Income (Loss) Per Common Share - Basic net income (loss) per common share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the year before giving effect to stock options and warrants considered to be dilutive common stock equivalents. Diluted net income (loss) per common share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common and potentially dilutive shares outstanding during the year after giving effect to convertible preferred stock, stock options and warrants. For the year ended July 31, 2002 and 2001, the effect 335,000 and 531,710 shares, respectively, of convertible preferred stock, options and warrants were excluded because their inclusion would have the effect of decreasing the loss per share.
For the year ended July 31, 2003, the following is a reconciliation of the numerators and denominators of basic and dilutive per share computations for income from continuing operations:
Income available to common shareholders | | $ | 7,246,359 | |
Average outstanding common shares | | | 45, 490,111 | |
Effect of dilutive securities: | | | | |
Options | | | 162,227 | |
Warrants | | | 13,601 | |
Convertible preferred stock | | | 100,000 | |
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| |
Average outstanding and potentially dilutive common shares | | | 45,765,939 | |
Basic income per share from continuing operations | | $ | 0.16 | |
Dilutive income per share from continuing operations | | $ | 0.16 | |
F-9
Financial Instruments – The carrying amounts and estimated fair value of our financial instruments are as follows:
| The carrying values of cash and cash equivalents, receivables, accounts payable and accrued expenses approximate fair values due to the short-term maturities of these instruments. |
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The carrying amount of long-term debt and short-term borrowings are estimated to approximate fair value as the actual interest rate is consistent with the rate estimated to be currently available for debt of similar term and remaining maturity. |
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Financial instruments, which potentially subject us to credit risk, consist principally of trade receivables. In the normal course of business, we provide credit to pharmaceutical wholesalers and chains, food wholesalers and chains, rack jobbers, convenience stores, and dentists. Ongoing credit evaluations are performed of customers to determine an appropriate allowance for credit losses. |
Comprehensive Income consists of net income (loss) and other gains and losses affecting shareholders’ equity that, under generally accepted accounting principles are excluded from net income (loss). Such items consist primarily of unrealized gains and losses on marketable equity investments and foreign currency translation gains and losses.
Shipping Costs – Costs of shipping products to customers are included in the cost of products sold.
New Accounting Pronouncements – In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The provisions of SFAS No. 150, which also include a number of new disclosure requirements, are effective for instruments entered into or modified after May 15, 2003 and pre-existing instruments as of the beginning of the first interim period that commences after June 15, 2003. The adoption of SFAS No. 150 did not have a significant effect on our results of operations or financial position.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The amendments set forth in SFAS No. 149 improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. The provisions of SFAS No. 149 are effective for contracts entered into or modified after June 30, 2003. We do not expect the adoption of SFAS No. 149 to have a significant effect on our results of operations or financial position.
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements.” FIN 46 prescribes how to identify variable interest entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. In October 2003, the implementation date of FIN 46 was deferred until the end of the first interim or annual period ending after December 15, 2003. We do not expect the adoption of FIN 46 to have a significant effect on our results of operations or financial position.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We have adopted the disclosure requirements of SFAS No. 148 (See Note 9).
In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 sets forth expanded disclosure requirements in the financial statements about a guarantor’s obligations under certain guarantees that it has issued. It also clarifies that, under certain circumstances, a guarantor is required to recognize a liability for the fair value of the obligation at the inception of the guarantee. Certain types of guarantees, such as product warranties, guarantees accounted for as derivatives, and guarantees related to parent-subsidiary relationships are excluded from the liability recognition provisions of FIN 45, however, they are subject to the disclosure requirements. The initial liability recognition provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financial statements for interim or annual periods ending after December 15, 2002. The adoption of FIN 45 did not have an effect on our results of operations or financial position.
F-10
In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which replaces EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).” The new standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. The statement is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. We do not expect that the adoption will have a significant impact on our financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” This Statement rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” SFAS No. 44, “Accounting for Intangible Assets of Motor Carriers” and SFAS No. 64, “Extinguishments of Debt Made to Satisfy Sinking Fund Requirements.” This Statement also amends SFAS No. 13, “Accounting for Leases,” to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 was effective for us in the third quarter of fiscal year 2003. The adoption of SFAS No. 145 did not have an effect on our results of operations or financial position.
Effective August 1, 2001, we adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 supercedes existing guidance on asset impairment under SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” Among other provisions, SFAS No. 144 changes the criteria for classifying an asset as held-for-sale. The standard also broadens the scope of businesses to be disposed of that qualify for reporting as discontinued operations, and changes the timing of recognizing losses on such operations. The adoption of SFAS No. 144 did not have a significant impact on our financial position or results of operations. Impairment losses totaled $140,000, $224,000 and $310,000 in 2003, 2002 and 2001, respectively.
In April 2001, the EITF reached consensus on Issue No. 00-25, “Vendor Income Statement Characterization of Consideration from a Vendor to a Retailer.” The Issue discusses accounting and income statement classification of costs, other than those directly addressed in Issue 00-14, that are incurred by a vendor (typically a manufacturer or distributor) to or on behalf of a customer (typically a retailer) in connection with the customer’s purchase or promotion of the vendor’s products. Such costs include consideration given to retailers for space in their stores (slotting fees), consideration given to obtain favorable display positions in the retailer’s stores and other promotional activity such as cooperative advertising. The Issue addresses the recognition and measurement of such costs and whether a vendor should classify such costs in its income statement when incurred as a reduction of revenues or as an expense item. The consensus on EITF No. 00-25 was effective for us on February 1, 2002. The effect of the adoption of EITF No. 00-25 did not have a material impact on our consolidated statement of operations.
In May 2000, the Financial Accounting Standards Board’s Emerging Issues Task Force (“EITF”) reached consensus on Issue No. 00-14, “Accounting for Certain Sales Incentives.” The Issue addresses the recognition, measurement, and income statement classification for certain sales incentives including coupons, rebates and free products. The consensus in Issue No. 00-14 was effective for us on February 1, 2002. The consensus requires certain sales incentives that were previously classified as selling, general and administrative expenses to be classified as a reduction in sales. The cost of free products is now recorded as a reduction of revenues from products sold.
The table below shows the effect of the Issue No. 00-14 and Issue No. 00-25 adjustment to revenues and selling, general and administrative expense for the year ended July 31, 2001
| | 2001 | |
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Pre-adoption net revenues | | $ | 31,686,392 | |
Reclassifications from selling, general and administrative expenses: | | | | |
Sales incentives | | | 933,596 | |
Co-op advertising | | | 42,035 | |
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Total Adjustments | | | 975,631 | |
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Net Revenues Reported | | $ | 30,710,761 | |
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F-11
2. Acquisitions
On December 4, 2001, we acquired the world marketing and distribution rights (excluding the Pacific Rim) for the FDA cleared ViziLite™ chemiluminescent light technology from The Trylon Corporation (“Trylon”) of Torrance, California. The rights acquired include the FDA-approved devices and methods of conducting endoscopic examinations of body cavities using chemiluminescent light sources.
In payment of the purchase price for the transaction, 2,000,000 shares of restricted common stock were issued, of which 1,625,000 shares were delivered to Trylon and 375,000 shares were placed into escrow. The shares of common stock are restricted in accordance with the following provisions: (i) all 2,000,000 shares are restricted within the meaning of Rule 144 under the Securities Act of 1933, as amended, (ii) 500,000 of the shares delivered to Trylon have an additional contractual restriction upon sale or transfer that will be removed at the earlier of ten years following the closing date or the achievement of certain future sales milestones of the ViziLite product, (iii) 375,000 of the other shares delivered to Trylon have an additional contractual restriction that will be removed at the earlier of ten years following the closing date or in the event of the submission of a new drug 510(k) application with the FDA for a new product line extension of the ViziLite™ product currently under development. The 375,000 shares in escrow are to remain in escrow until the date upon which FDA marketing clearance is received on the new product line extension of the ViziLite™ product described in item (iii) above. If such clearance is not received on or before the second anniversary of the closing date, then subject to certain exceptions, the stock in escrow is to be returned to us and cancelled.
The 1,625,000 shares of restricted common stock that were delivered were valued at $2,945,000 as follows: (i) the fair value of the 750,000 shares restricted within the meaning of Rule 144 but not otherwise restricted, were valued at $1,853,000 which was based upon the common stock share market price of $2.47 on December 4, 2001; (ii) the 500,000 shares of restricted common stock subject to additional contractual restrictions relating to sales milestones were valued at $619,000 and were discounted from the December 4, 2001 share price based upon the length of time and probability of achieving the requisite sales milestones; and (iii) the 375,000 restricted shares of common stock subject to additional contractual restrictions tied to FDA submissions were valued at $473,000 and were discounted based upon the length of time and probability of submitting an acceptable new drug 510(k) application to the FDA. The $2,472,000 of value referenced in items (i) and (ii) above was recorded as an intangible asset as a license. The $473,000 in value referenced in item (iii) above was recorded as research and development and expensed.
On October 15, 2003, a mediation settlement was concluded affecting 875,000 shares delivered to Trylon and the 375,000 shares placed into escrow such that the contractual restriction on these shares will be only removed upon the achievement of certain government approval and other milestones and not at the earlier of 10 years following the closing date or the achievement of certain future sales milestones as was included in the original agreement. In addition, royalty payments were reduced.
In December 2001, we entered into a distributorship agreement with Patterson Dental Company to supply certain products for the dental industry, including the ViziLite™ product, in the United States and Canada. In May 2003, this distribution agreement was modified to a non-exclusive basis. In February 2002, we entered into a Memorandum of Understanding with Trylon and the World Medical Trade Organization Inc. (“WMTO”), whereby we will supply products including the ViziLite product to WMTO for distribution in various countries in the Pacific Rim. Foreign sales to date have not been significant.
On February 1, 2001, we acquired the patent rights and the Antioch, Illinois manufacturing operations for swab products from National Healthcare Manufacturing Corporation, headquartered in Winnipeg, Canada for approximately $2.3 million in a combination of cash and preferred stock. (See Note 11). Intellectual property, inventory, plus molding, labeling, filling and sealing equipment were included in the acquisition. The business unit is part of our Pharmaceuticals Group and is known as Innovative Swab Technologies.
3. Gains from Contract Settlement and Sale of Assets
Contract Settlement
On April 14, 2003, we reached agreement in a dispute with our former CRO and received a $20 million settlement payment on June 30, 2003. As part of the settlement, we incurred approximately $5.2 million in legal, consulting and other related obligations, resulting in a net gain of approximately $14.8 million.
F-12
Sale of Assets
On July 30, 2003, we sold our investment in PracticeWares, Inc. (“PracticeWares”) for $525,000. As described in Note 4, we received this investment as part of the consideration for the sale of our Dental Supply Segment. Since no cost basis was assigned to this investment, the entire cash proceeds from the sale were recorded as pre-tax gain.
In the year ended July 31, 2001, we recorded a charge of $310,000 in the Nutraceuticals segment to write down the carrying amount of the land and buildings of its former location in Prescott, Arizona to an estimated fair value related to its anticipated sale. The building was sold in February 2001.
4. Discontinued Operation
In November 2001, we decided to sell the operations of our Zila Dental Supply (“ZDS”) business. These operations were sold in two separate transactions during the second fiscal quarter of 2002. The accompanying consolidated financial statements have been prepared to reflect the ZDS business including any gain (loss) on sale as discontinued operations for all periods presented.
This business segment was comprised of the full-service and mail order businesses of Zila Dental Supply. ZDS’s full-service assets were sold on November 5, 2001 to Henry Schein, Inc. of Melville, NY (NASDAQ: HSIC) for approximately $5.8 million in cash resulting in a pre-tax gain of approximately $823,000. Proceeds from the sale were used to repay borrowings outstanding under the revolving line of credit with Congress Financial Corporation (“Congress”).
The ZDS mail order operations (assets and liabilities) were sold on December 4, 2001 to PracticeWares for approximately $8.0 million in one short and two long-term notes. Approximately $5.7 million of the $8.0 million purchase price (net of post closing adjustments) was due and payable January 11, 2002. We extended the maturity date of the short-term note, upon payment of accrued and prepaid interest, to February 15, 2002, and further extended the note to March 1, 2002, with interest prepaid through the new maturity date.
The note was not paid on the due date and in March 2002 we agreed in principle to permit PracticeWares to restructure the terms of the sale. In June 2002, we reached a final agreement with PracticeWares whereby we received cash of approximately $4,130,000, plus a 19.0% ownership interest in PracticeWares (on a fully diluted basis) in full satisfaction of the notes. On June 18, 2002, we received $3.9 million from PracticeWares, which included approximately $130,000 in accrued interest. $200,000 was held in escrow for 60 days to offset certain indemnifications of Zila to PracticeWares, resulting in a pre-tax loss from the disposal of the mail order assets and liabilities of approximately $679,000. Proceeds from the sale were used to repay borrowings outstanding under the revolving line of credit with Congress.
As a result of PracticeWare’s failure to pay the short-term notes when due, the transaction to sell the mail order business did not qualify as a sale for accounting purposes until June 18, 2002. ZDS’s net loss of $550,000 for the period from December 4, 2001 to June 18, 2002 is reflected in the statement of operations as income (loss) from operations of the discontinued Dental Supply Segment. In connection with the sale, we retained three operating leases and recorded a reserve for future minimum lease payments in excess of expected sublease income of $430,000. The reserve is included in the loss on disposal of the mail order assets.
The results of the discontinued ZDS business are as follows, in thousands:
| | 2003 | | 2002 | | 2001 | |
| |
| |
| |
| |
Net sales | | $ | | | $ | 23,426 | | $ | 41,630 | |
Net income (loss) | | $ | 10 | | $ | (815 | ) | $ | (121 | ) |
5. Inventories
Inventories consist of the following at July 31:
| | 2003 | | 2002 | |
| |
| |
| |
Finished goods | | $ | 2,217,396 | | $ | 2,455,080 | |
Work in process | | | 555,153 | | | 1,806,783 | |
Raw materials | | | 5,670,217 | | | 4,899,401 | |
Inventory reserves | | | (354,544 | ) | | (292,725 | ) |
| |
|
| |
|
| |
Total inventories | | $ | 8,088,222 | | $ | 8,868,539 | |
| |
|
| |
|
| |
F-13
6. Property and Equipment
Property and equipment consists of the following at July 31:
| | 2003 | | 2002 | |
| |
| |
| |
Land | | $ | 619,917 | | $ | 619,917 | |
Building and improvements | | | 5,651,665 | | | 5,641,896 | |
Furniture and equipment | | | 2,219,714 | | | 2,013,720 | |
Leasehold improvements and other assets | | | 368,186 | | | 377,117 | |
Production and warehouse equipment | | | 6,271,838 | | | 4,812,294 | |
| |
|
| |
|
| |
Total property and equipment | | | 15,131,320 | | | 13,464,944 | |
Less accumulated depreciation and amortization | | | 5,650,013 | | | 4,616,645 | |
| |
|
| |
|
| |
Property and equipment – net | | $ | 9,481,307 | | $ | 8,848,299 | |
| |
|
| |
|
| |
Depreciation expense related to property and equipment for 2003, 2002 and 2001 was $1,114,000, $1,083,000, and $952,000, respectively.
7. Intangible Assets
Intangible assets consist of the following at July 31:
| | 2003 | | 2002 | |
| |
| |
| |
| | Gross
Carrying
Amount | | Accumulated
Amortization | | Net
Carrying
Amount | | Gross
Carrying
Amount | | Accumulated
Amortization | | Net
Carrying
Amount | |
| |
| |
| |
| |
| |
| |
| |
Amortizable intangibles: | | | | | | | | | | | | | | | | | | | |
Purchased technology rights | | $ | 7,419,473 | | $ | 3,430,509 | | $ | 3,988,964 | | $ | 7,419,473 | | $ | 2,951,894 | | $ | 4,467,579 | |
Trademarks and other intangible assets: | | | | | | | | | | | | | | | | | | | |
Trademarks | | | 11,574,237 | | | 2,652,207 | | | 8,922,030 | | | 11,487,214 | | | 2,180,836 | | | 9,306,378 | |
Patents | | | 3,049,289 | | | 735,712 | | | 2,313,577 | | | 2,735,623 | | | 668,868 | | | 2,066,755 | |
Licensing costs | | | 2,709,144 | | | 488,084 | | | 2,221,060 | | | 2,711,616 | | | 225,246 | | | 2,486,370 | |
Other | | | 536,180 | | | 272,825 | | | 263,355 | | | 738,582 | | | 241,433 | | | 497,149 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total trademarks and other intangible assets | | | 17,868,850 | | | 4,148,828 | | | 13,720,022 | | | 17,673,035 | | | 3,316,383 | | | 14,356,652 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total amortizable intangible assets | | | 25,288,323 | | | 7,579,337 | | | 17,708,986 | | | 25,092,508 | | | 6,268,277 | | | 18,824,231 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Unamortizable intangible asset: | | | | | | | | | | | | | | | | | | | |
Goodwill | | | 12,446,792 | | | 5,516,600 | | | 6,930,192 | | | 16,530,985 | | | 5,516,600 | | | 11,014,385 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total intangible assets | | $ | 37,735,115 | | $ | 13,095,937 | | $ | 24,639,178 | | $ | 41,623,493 | | $ | 11,784,877 | | $ | 29,838,616 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Changes in the carrying amount of goodwill for the year ended July 31, 2003, follow:
| | Nutraceuticals | | Pharmaceuticals | | Biotechnology | | Total | |
| |
| |
| |
| |
| |
Balance, August 1, 2002 | | $ | 2,896,926 | | $ | 8,117,459 | | $ | | | $ | 11,014,385 | |
Transitional impairment losses | | | | | | 4,084,193 | | | | | | 4,084,193 | |
| |
|
| |
|
| |
|
| |
|
| |
Balance, July 31, 2003 | | $ | 2,896,926 | | $ | 4,033,266 | | $ | | | $ | 6,930,192 | |
| |
|
| |
|
| |
|
| |
|
| |
F-14
In accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets,” we evaluate intangibles and other assets for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable.
In fiscal years 2003 and 2002, asset impairment charges of approximately $141,000 and $224,000, respectively, were recorded related to the write down of a mold and certain intangible assets related to the Pro-Ties™ product line and the Peridex® product distribution rights for Western Europe. The net present value of expected future cash flows for each of these assets was used to determine the amount of impairment. The charges are included in the Pharmaceuticals reporting segment.
In accordance with SFAS No. 142, we discontinued the amortization of goodwill, effective August 1, 2002. We completed the transitional goodwill impairment test for our reporting units and recorded a charge of $4,084,000 as of August 1, 2002 relating to our Pharmaceutical segment.
Amortization of intangible assets during fiscal 2003, 2002 and 2001 was $1,318,000, $2,385,000 and $2,223,000, respectively. For fiscal years 2004 through 2008, the amortization of intangibles is estimated to be approximately $1,300,000 each year.
Loss from continuing operations and net income (loss), as reported and as adjusted with the adoption of SFAS No. 142, are presented below.
| | 2003 | | 2002 | | 2001 | |
| |
|
| |
|
| |
|
| |
Income (loss) from continuing operations before accounting change, as reported | | $ | 11,359,522 | | $ | (11,338,280 | ) | $ | (6,269,298 | ) |
Net income (loss) from continuing operations before accounting change, excluding goodwill amortization | | | 11,359,522 | | | (10,158,052 | ) | | (5,105,123 | ) |
Basic and Diluted | | | | | | | | | | |
Earnings per share, as reported | | | 0.25 | | | (0.25 | ) | | (0.15 | ) |
Earnings per share, excluding goodwill amortization | | | 0.25 | | | (0.23 | ) | | (0.12 | ) |
8. Short-term Borrowings and Long-Term Debt
In December 2002, we entered into an agreement with PharmaBio Development, Inc., (“PharmaBio”), the strategic investment group of Quintiles Transnational Corp, our contract research organization. Under this agreement, PharmaBio invested $500,000 in our Company. In return for the investment, we agreed to pay to PharmaBio an amount equal to 5% of all net sales of the OraTest® product in the European Union and the United States. The aggregated amount of the royalty cannot exceed $1.25 million and the royalty is payable quarterly. The investment was recorded as long-term debt and will be amortized using the effective interest method.
At July 31, 2003, we had (i) a short-term note payable of $129,500 at 6.20% for installments due on various insurance policies; (ii) the short-term loan for equipment of $25,000; and (iii) no short-term borrowings outstanding against our line of credit with Congress. On July 31, 2002, short-term borrowings consisted of $92,000 at 7.88% for installments due on various insurance policies and the short-term portion of an equipment loan for $8,000.
On August 27, 2001, we entered into a Loan and Security Agreement (the “Agreement”) whereby Congress Financial would provide a $12 million revolving line of credit at an interest rate equal to the prime rate plus 3/4 percent. The amount of funds available from the line of credit is based upon a percentage of the value of eligible receivables and inventory and was $8.4 million at July 31, 2003. The obligations under the Agreement are collateralized by various assets, including, but not limited to trade accounts receivable, inventories, equipment and intangible assets. The parent company, Zila, Inc. and all of its direct and indirect operating subsidiaries guarantee the obligations under the Agreement. The Agreement expires August 17, 2004. Under the Agreement, we are required to maintain adjusted tangible net worth, as defined in the Agreement. At July 31, 2003, our adjusted tangible net worth, as defined, was $32.3 million compared to the required amount of $12.0 million.
F-15
Long-term debt consisted of the following at July 31:
| | 2003 | | 2002 | |
| |
|
| |
|
| |
IDA bond payable, Series A | | $ | 3,577,770 | | $ | 3,900,000 | |
IDA bond payable, Series B | | | | | | 103,553 | |
PharmaBio | | | 500,000 | | | | |
Notes payable for equipment with interest rates between 6.34% and 12.25% with maturities through 2006 | | | 137,805 | | | 96,091 | |
| |
|
| |
|
| |
| | | 4,215,575 | | | 4,099,644 | |
Less current portion | | | 487,449 | | | 489,161 | |
| |
|
| |
|
| |
Long-term portion | | $ | 3,728,126 | | $ | 3,610,483 | |
| |
|
| |
|
| |
In April 1999, Oxycal entered into a transaction with The Industrial Development Authority of the County of Yavapai (the “Authority”) in which the Authority issued $5.0 million in Industrial Development Revenue Bonds (the “Bonds”). The proceeds from the Bonds were loaned to Oxycal for the construction of a new manufacturing and laboratory facility. The initial offerings of Bonds consist of $3.9 million Series A and $104,000 Taxable Series B and mature in 2019. As of July 31, 2003, the Series B were repaid. The Bonds bear a variable interest rate that was 1.1% at July 31, 2003. In connection with the issuance of the Bonds, the Authority required that Oxycal obtain, for the benefit of the Bondholders, an irrevocable direct-pay letter of credit to secure payment of principal and interest. Zila, Inc. guaranteed the letter of credit. The letter of credit expires on March 15, 2004, and the Bond trustee must be notified by February 1, 2004 that a replacement letter of credit has been obtained.
Aggregate annual maturities of long-term debt for the fiscal years ending July 31 are as follows:
| | | | |
2004 | | $ | 487,449 | |
2005 | | | 501,923 | |
2006 | | | 425,784 | |
2007 | | | 425,784 | |
2008 | | | 425,784 | |
2009 and thereafter | | | 1,948,851 | |
| |
|
| |
Total | | | 4,215,575 | |
Less current portion | | | 487,449 | |
| |
|
| |
Long-term portion | | $ | 3,728,126 | |
| |
|
| |
9. Stock Options and Warrants
a. Stock Options - We adopted the Zila, Inc. 1997 Stock Option Award Plan, effective February 5, 1997, authorizing the Board of Directors to grant options to employees and certain employee directors to purchase up to 1,000,000 shares of common stock. On December 7, 2000, the plan was amended to increase the authorized number of shares to 3,000,000. The options are issuable at an exercise price equal to the market closing price on the date of grant. Options may be exercised up to ten years from the date of grant. In fiscal 2003, 2002 and 2001, we granted options to purchase 445,000, 513,000 and 354,800 shares of common stock, respectively, to employees. At July 31, 2003, 1,941,799 shares were available for grant under this plan.
On September 1, 1988, we adopted a Stock Option Award Plan, authorizing the Board of Directors to grant options to employees and certain employee-directors to purchase up to 4,000,000 shares of common stock. The plan was amended December 8, 1995 to increase the authorized number of shares to 5,000,000. The options were issuable at an exercise price no less than the market value at the date of grant. Options may be exercised at any time up to ten years from the date of grant. At July 31, 2003, no shares were available for grant under this plan.
We adopted a Zila, Inc. Non-Employee Directors Stock Option Plan, effective October 20, 1989, authorizing the Board of Directors to grant options of 100,000 shares to non-employee members of our Board of Directors in increments of 2,500 shares per director each year. Grants under the plan are for services provided to us as a director. Amendments to the plan dated December 8, 1995 and September 26, 2002 increased the authorized number of shares to 200,000 and 700,000, respectively. The September 26, 2002 amendment which was approved by the shareholders at the January 14, 2003 annual meeting, also provided for an initial grant of 20,000 options to new directors and an increase in annual option grants to existing directors from 2,500 stock options to 20,000 stock options. These stock options vest quarterly in equal increments. The options are issuable at an exercise price equal to the market value at the date of grant. All options may be exercised at any time up to five years from the date of grant. At July 31, 2003, 500,000 shares were available for grant under this plan.
F-16
A summary of the status of the option plans as of July 31, 2003, 2002 and 2001 and changes during the years then ended is presented below:
| | 2003 | | 2002 | | 2001 | |
| |
| |
| |
| |
| | Shares | | Weighted
Average
Exercise
Price | | Shares | | Weighted
Average
Exercise
Price | | Shares | | Weighted
Average
Exercise
Price | |
| |
| |
| |
| |
| |
| |
| |
Outstanding at beginning of year | | | 2,196,418 | | $ | 4.42 | | | 2,097,943 | | $ | 5.07 | | | 2,576,354 | | $ | 5.07 | |
Granted | | | 580,000 | | | 1.59 | | | 550,500 | | | 1.71 | | | 354,800 | | | 2.64 | |
Exercised | | | (5,000 | ) | | 1.05 | | | 0 | | | | | | (249,752 | ) | | 1.19 | |
Forfeited/expired | | | (1,472,457 | ) | | 4.84 | | | (452,025 | ) | | 4.38 | | | (583,459 | ) | | 5.27 | |
| |
|
| | | | |
|
| | | | |
|
| | | | |
Outstanding at end of year | | | 1,298,961 | | | 2.69 | | | 2,196,418 | | | 4.42 | | | 2,097,943 | | | 5.07 | |
| |
|
| | | | |
|
| | | | |
|
| | | | |
Options exercisable at year-end | | | 759,714 | | | 3.30 | | | 1,496,763 | | | 5.51 | | | 1,386,321 | | | 5.94 | |
| |
|
| | | | |
|
| | | | |
|
| | | | |
The weighted-average grant-date fair value of options granted during the years ended July 31, 2003, 2002 and 2001 was $303,000, $375,000 and $606,000, respectively
The following table summarizes information regarding stock options outstanding as of July 31, 2003:
Options Outstanding | | Options Exercisable | |
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
| |
Range of Exercise Prices | | Number
Outstanding
At
July 31, 2003 | | Weighted
Average
Remaining
Contractual Life | | Weighted
Average
Exercise
Price | | Number
Exercisable
at
July 31, 2003 | | Weighted
Average
Exercise
Price | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
$0.76 - 3.00 | | | 819,001 | | | 8.0 | | $ | 1.43 | | | 386,421 | | $ | 1.35 | |
3.01 - 4.50 | | | 296,925 | | | 6.6 | | | 3.18 | | | 190,258 | | | 3.19 | |
4.51 - 6.00 | | | 34,844 | | | 3.2 | | | 5.28 | | | 34,844 | | | 5.28 | |
6.01 - 8.00 | | | 93,191 | | | 3.4 | | | 6.99 | | | 93,191 | | | 6.99 | |
8.01 - 9.92 | | | 55,000 | | | 5.4 | | | 9.88 | | | 55,000 | | | 9.88 | |
| |
|
| | | | | | | |
|
| | | | |
Total | | | 1,298,961 | | | 7.1 | | | 2.69 | | | 759,714 | | | 3.30 | |
| |
|
| | | | | | | |
|
| | | | |
We apply Accounting Principles Board (“APB”) Opinion No. 25 and related interpretations in accounting for its stock-based employee compensation plans and the director’s stock option plan. Accordingly, no compensation cost has been recognized for stock-based employee and director compensation plans. Had compensation cost been computed based on the fair value of awards on the date of grant, utilizing the Black-Scholes option-pricing model, consistent with the method stipulated by SFAS No. 123, net income (loss) attributable to common shareholders and income (loss) per share attributable to common shareholders for the years ended July 31, 2003, 2003 and 2001 would have been increased or reduced to the pro forma amounts indicated below, followed by the model assumptions used:
| | July 31, | |
| |
|
|
|
|
|
|
|
| |
| | 2003 | | 2002 | | 2001 | |
| |
|
| |
|
| |
|
| |
Net income (loss) attributable to common shareholders: | | | | | | | | | | |
As reported | | $ | 7,246,000 | | $ | (12,069,000 | ) | $ | (6,390,000 | ) |
Pro forma | | $ | 6,943,000 | | $ | (12,444,000 | ) | $ | (6,996,000 | ) |
Net income (loss) attributable to common shareholders per basic share outstanding: | | | | | | | | | | |
As reported | | $ | .16 | | $ | (.27 | ) | $ | (.15 | ) |
Pro forma | | $ | .15 | | $ | (.28 | ) | $ | (.16 | ) |
Net income (loss) attributable to common shareholders per diluted share outstanding: | | | | | | | | | | |
As reported | | $ | .16 | | $ | (.27 | ) | $ | (.15 | ) |
Pro forma | | $ | .15 | | $ | (.28 | ) | $ | (.16 | ) |
Black-Scholes model assumptions: | | | | | | | | | | |
Risk-free interest rate | | | 3.13 | % | | 2.62 | % | | 4.8 | % |
Expected volatility | | | 80 | % | | 72 | % | | 74 | % |
Expected term (in years) | | | 5.56 | | | 7.10 | | | 9.3 | |
Dividend yield | | | 0 | % | | 0 | % | | 0 | % |
b. Warrants – We have issued warrants to various investors, shareholders and other third parties in connection with services provided. These warrants were valued using a Black Scholes model and charged to expense. Warrants issued in exchange for goods are expensed at the fair value of the consideration received. During the years ended July 31, 2003, and 2001 warrants issued for goods or services were valued at $71,000 and $30,000, respectively, and are included as a
F-17
component of selling, general and administrative expenses. Activity related to such warrants, which expire at various dates through September 2008, is summarized as follows:
| | Number of
Shares | | Warrant Price
Per Share | |
| |
| |
| |
Outstanding, July 31, 2000 | | | 1,068,357 | | | $3.00-9.92 | |
Issued | | | 15,000 | | | 4.00-5.00 | |
Exercised | | | (149,870 | ) | | 3.00 | |
Expired | | | (908,487 | ) | | 3.00-9.92 | |
| |
|
| | | | |
Outstanding, July 31, 2001 | | | 25,000 | | | 4.00-5.00 | |
No activity | | | | | | | |
| |
|
| | | | |
Outstanding, July 31, 2002 | | | 25,000 | | | 4.00-5.00 | |
Issued | | | 104,000 | | | 0.98 | |
Cancelled | | | (10,000 | ) | | 4.91 | |
| |
|
| | | | |
Outstanding, July 31, 2003 | | | 119,000 | | | 0.98-5.00 | |
| |
|
| | | | |
We entered into an agreement with a financial advisor during fiscal 2002 to perform consulting services. Under the agreement, we are committed to issue warrants to purchase 30,000 shares of its common stock for $4.00 per share. At July 31, 2003, $28,000 is included in accrued liabilities representing the fair value of the warrants expected to be issued.
c. Stock Purchase Plan – Under The Zila, Inc. Employee Stock Purchase Plan, we are authorized, as of July 31, 2001, to issue up to 2 million shares of common stock to our eligible employees. Eligible employees may have up to 15% of eligible compensation deducted from their pay and/or they may make a lump sum payment on the last day of the offering. The employee’s contributions are applied to the purchase of shares of common stock. The purchase price for each share of stock is 85% of the lower of the closing price on the first or last day of the offering period. The plan is considered non-compensatory under APB Opinion No. 25. A total of 143,700 and 12,400 shares were purchased in fiscal 2003 and 2002, respectively, for aggregate proceeds of $140,000 and $25,000, respectively.
10. Income Taxes
The consolidated income tax (benefit) provision consists of the following for the years ended July 31 (in thousands):
| | 2003 | | 2002 | | 2001 | |
| |
| |
| |
| |
Current: | | | | | | | | | | |
Federal | | $ | 95,000 | | $ | (280,000 | ) | | | |
State | | | 93,000 | | | 17,000 | | | | |
| |
|
| |
|
| | | | |
Total current | | | 188,000 | | | (263,000 | ) | | | |
| |
|
| |
|
| | | | |
Deferred: | | | | | | | | | | |
Federal | | | | | | 3,648,000 | | $ | (314,000 | ) |
State | | | | | | 569,000 | | | (65,000 | ) |
| |
|
| |
|
| |
|
| |
Total deferred | | | | | | 4,217,000 | | | (379,000 | ) |
| |
|
| |
|
| |
|
| |
Total consolidated income tax (benefit) provision | | $ | | | $ | 3,954,000 | | $ | (379,000 | ) |
| |
|
| |
|
| |
|
| |
A reconciliation of the federal statutory rate to the effective income tax rate for the years ended July 31 is as follows:
| | 2003 | | 2002 | | 2001 | |
| |
|
| |
|
| |
|
| |
Federal statutory rate | | | 34 | % | | (34 | )% | | (34 | )% |
Adjustments: | | | | | | | | | | |
State income taxes - net of federal tax effects | | | 5 | | | (5 | ) | | (1 | ) |
Effect of foreign tax rates | | | | | | | | | 1 | |
Non-deductible meal and entertainment expenses | | | 1 | | | 1 | | | 1 | |
Non-deductible intangible amortization | | | 4 | | | 6 | | | 7 | |
Non-deductible goodwill related to sale of assets | | | | | | | | | | |
Increase (decrease) in valuation allowance | | | (42 | ) | | 86 | | | 20 | |
| |
|
| |
|
| |
|
| |
Effective tax rate | | | 2 | % | | (54 | )% | | (6 | )% |
| |
|
| |
|
| |
|
| |
F-18
The components of deferred income tax assets and liabilities for the years ended July 31 are shown below (dollars in thousands):
| | 2003 | | 2002 | | 2001 | |
| |
|
| |
|
| |
|
| |
Deferred income tax assets: | | | | | | | | | | |
Net operating loss carry forwards | | $ | 2,480 | | $ | 8,257 | | $ | 5,563 | |
Capital loss carry forward | | | 185 | | | | | | | |
Allowance for obsolete or discontinued inventory | | | 4 | | | 112 | | | 74 | |
Alternative minimum tax credit | | | 249 | | | 154 | | | 154 | |
Book basis versus tax basis differences | | | 1,957 | | | 447 | | | 274 | |
Reserve for litigation | | | 55 | | | | | | 40 | |
Allowance for doubtful accounts | | | 110 | | | 104 | | | 123 | |
Accrued vacation | | | 99 | | | 20 | | | 143 | |
Deferred revenue | | | | | | 8 | | | 3 | |
Severance cost | | | | | | | | | 48 | |
Accrued bonus | | | 86 | | | | | | | |
Other | | | 34 | | | | | | 165 | |
| |
|
| |
|
| |
|
| |
Total deferred income tax assets | | | 5,259 | | | 9,102 | | | 6,587 | |
Valuation allowance | | | (5,259 | ) | | (9,102 | ) | | (2,370 | ) |
| |
|
| |
|
| |
|
| |
Net deferred income tax assets | | $ | 0 | | $ | 0 | | $ | 4,217 | |
| |
|
| |
|
| |
|
| |
Deferred income taxes reflect the tax effect of temporary differences between the amounts of assets and liabilities recognized for financial reporting and tax purposes. Net deferred tax assets were offset with a valuation allowance due to a lack of earnings history.
We regularly review our deferred tax assets and related valuation reserves in accordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”). SFAS No. 109 requires an assessment of all available evidence, both positive and negative, to determine whether a valuation allowance is needed
During fiscal year 2003, due to the former CRO settlement, a significant portion of federal net operating loss carry forwards and all of the state net operating loss carry forwards were absorbed. At July 31, 2003, we had federal net operating loss carry forwards of approximately $6,400,000 which expire in years 2021 and 2022 and capital loss carry forwards of $475,000 which expire in 2008. Net operating loss carry forwards for state income tax purposes were fully utilized during fiscal 2003.
During fiscal years 2003 and 2002, after consideration of available positive and negative evidence, we determined that it was more likely than not that certain future tax benefits will not be realized. Accordingly, valuation allowances were provided that reduced the net deferred tax assets to $0 as of July 31, 2003 and 2002. During fiscal 2002, we recorded a tax benefit of $280,000 related to the filing of amended federal income tax returns during the third quarter of fiscal 2002. The amended returns were filed pursuant to section 102 of the “Job Creation and Worker Assistance Act of 2002,” which extended the use of NOL carry backs over five years instead of three.
During fiscal year 2001, after consideration of available positive and negative evidence, we recorded $1,808,000 in deferred tax assets offset by an increase in the deferred valuation allowance of $1,422,000, which resulted in a net income tax benefit of $386,000. The increase in the valuation allowance was primarily due to the operating losses, which had occurred during the year.
The comprehensive losses in fiscal years 2003 ($300) and 2002 ($226,000), and the comprehensive income for fiscal year 2001 ($79,000), reflect no income tax benefit or expense due to the recording of valuation allowances.
11. Convertible Preferred Stock
On February 1, 2001, we issued 100,000 shares of Series B convertible preferred stock to National Healthcare Manufacturing Corporation, U.S. as part of the acquisition discussed in Note 2. The preferred stock is convertible into shares of common stock at any time at a conversion ratio of one to one. The holders of the preferred stock are entitled to receive cumulative quarterly dividends at a rate of $0.0975 per share per fiscal quarter, payable in arrears. Holders of the preferred shares have no voting rights except as required by applicable law. We paid dividends of $49,000 and $29,000 during fiscal years 2003 and 2002, respectively. No dividends were paid in 2001. At July 31, 2003, accumulated accrued dividends are $19,500.
F-19
12. Treasury Stock
During the quarter ended January 31, 2000, we began acquiring shares of its common stock under our stock repurchase program announced in November 1999. The program authorized the repurchase of up to one million shares of Zila common stock from time to time on the open market depending on market conditions and other factors. As of July 31, 2003, we had purchased 225,100 shares of common stock at an aggregate cost of $571,373.
13. Commitments and Contingencies
FDA approval of the OraTest® product
We are pursuing FDA approval of a New Drug Application (“NDA”) for its OraTest® products. The initiation of the marketing of the OraTest® products in the United States is dependent upon the approval of the NDA by the FDA. During 1994, the FDA approved its application for an Investigational New Drug for OraTest®, which allows us to manufacture the product in the United States for clinical studies and export to certain foreign countries. In November 1998, the FDA notified us that the OraTest® NDA was being given “priority review,” which targeted agency review within six months from September 3, 1998, the date when the Company provided additional data to the FDA. On January 13, 1999, the FDA’s Oncologic Drugs Advisory Committee (the “Committee”) met to review the OraTest® NDA and recommended, among other things, that the FDA not approve the NDA as submitted. Subsequent to the Committee meeting, our representatives engaged in a dialog with the FDA, culminating in meetings at the agency in 1999 and 2000.
On March 3, 1999, we received an action letter from the FDA outlining certain deficiencies in the OraTest® NDA that prevented the FDA from approving the product at that time. The FDA’s letter detailed a procedure for amending the NDA to rectify those matters. In November 1999, we contracted with ILEX™ Oncology Services, Inc. (“ILEX”), a wholly-owned subsidiary of ILEX™ Oncology, Inc. of San Antonio, Texas, for management of clinical research and liaison with the FDA related to the Company’s pursuit of regulatory approval for the OraTest® oral cancer detection product.
In December 2002, we transitioned the OraTest clinical trials to Quintiles Transnational, the nation’s largest pharmaceutical services company. This was the result of an extensive review of several proposals received from some of the largest, highest quality and most prominent CRO’s with worldwide capabilities. Quintiles completed the transition successfully without compromising any of our current study data. Factors that will affect the cost and timing of completion of the clinical trials include but are not limited to: (i) patient enrollment rates, (ii) tumor formation rate within the study population (iii) compliance with the study protocol and related monitoring, (iv) level of funding throughout the study, and (v) protocol modifications.
Litigation
Zila and certain of its former officers were named as defendants in a consolidated First Amended Class Action Complaint filed July 6, 1999 in the United States District Court for the District of Arizona under the caption In re Zila Securities Litigation, No. CIV 99 0115 PHX EHC. The First Amended Class Action Complaint sought damages in an unspecified amount on behalf of a class consisting of purchasers of its securities for alleged violations of the federal securities laws. During the fourth quarter 2001, the parties settled this matter without a material impact on the Company’s financial statements.
On December 19, 2001, Zila and Joseph Hines, its former President, reached a settlement with the Securities and Exchange Commission (the “Commission”) relating to certain public statements made by the Company in January 1999 with respect to the prospects for approval by the FDA of the OraTest® product.
Pursuant to the settlement, the Commission made findings related to an unsigned draft report that had been prepared by the FDA staff and delivered to the Company on or about December 28, 1998. The unsigned draft report recommended against approval of the OraTest® product. The Commission found that, in public statements made by the Company during the two-week period subsequent to its receipt of the unsigned draft report and prior to an FDA advisory committee meeting that was held on January 13, 1999, the Company and Mr. Hines should have disclosed the receipt of the unsigned draft report. The Commission acknowledged the Company’s position that, at the time, it was represented by experienced FDA counsel who had advised the Company that its OraTest® NDA was approvable, but the Commission concluded that the receipt of the unsigned draft report should have been disclosed in the Company’s public statements, and that the failure to do so constituted a violation of Section 10(b) of the Securities Exchange Act of 1934 (the “Act”) and Rule 10b-5 hereunder.
In order to resolve the matter, the Company and Mr. Hines submitted Offers of Settlement, which the Commission accepted. Without admitting or denying the Commission’s findings, the Company and Mr. Hines consented to the entry of an Order Instituting Public Administrative Proceedings pursuant to Section 21C of the Act and the issuance of a Cease-and-Desist Order prohibiting future violations of such Section and Rule. Mr. Hines is a no longer a director, an officer or employee of Zila.
F-20
In connection with the acquisition of patent rights in 1980, we agreed to pay Dr. James E. Tinnell (“Tinnell”), the inventor of one of the Company’s treatment composition, a royalty of 5% of gross sales of the invention disclosed in his then pending patent application. In September 2000, we notified Tinnell that we would no longer pay such royalties since the obligations ceased in August 1998 when the related product patents expired and we furthermore requested reimbursement of royalties paid since August 1998. We then filed suit in Federal District Court requesting a declaratory judgment that we had no royalty obligations to Tinnell and a judgment for the overpaid royalties. Tinnell asserted several counterclaims. The court has since ruled in our favor stating that we do not owe royalty obligations to Tinnell and denied several of Tinnell’s counterclaims. However, one of Tinnell’s counterclaims is still outstanding for breach of contract. Furthermore, the court has not ruled on our request for reimbursement of overpaid royalties. The Company currently intends to request the Court to rule on Zila’ claim for reimbursement and prepare for trial on the remaining breach of contract issue.
In January 2003,we filed a suit for patent infringement against Beutlich Pharmaceuticals, LP (“Beutlich”) alleging that they sold “dry-handle swabs” that infringe upon our IST product swab patent. In February 2003, the Arizona court issued a temporary restraining order in our favor that stopped Beutlich from selling their swabs. In May 2003, the manufacturer of the swab that Beutlich was selling, Viridian Packaging Solutions, LLC. (“Viridian”) of Gurnee, Illinois, filed a declaratory judgment action in the Northern District of Illinois which has jurisdiction over all Federal cases filed in the metropolitan Chicago area. The Viridian suit seeks a declaration of non-infringement and patent invalidity. In August 2003, the Arizona court agreed to transfer the case to the Northern District of Illinois. We intend to vigorously defend our intellectual property rights. If Viridian prevails, sales of IST product swabs could be detrimentally affected.
In November 2001, we filed a suit for trademark infringement and trade secret misappropriation against Darrell Van Dyke and GMP Products, LLC (“Van Dyke”) in U.S. District Court for the Northern District of Illinois. In December 2002, the court entered a final judgment against us. Subsequently, the defendants brought a motion to recover their attorney’s fees and other costs incurred in defending the action. On September 29, 2003, the court awarded $131,700 to the defendants. We intend to appeal this decision. Our legal counsel has advised us there is a high probability of success in our appeal process and furthermore even if we are not successful on appeal, the amount is likely to be significantly lower than the District Court’s judgment. We have not accrued for this legal matter in fiscal year 2003.
The Company is subject to other legal proceedings and claims, which arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect the Company’s financial position or results of operations.
OraTest® Product
We also have approximately $359,000 of ZTC™ drug substance, the active ingredient in the OraTest® product, at our manufacturing facility in Phoenix, AZ. We intend to realize the value of this drug substance through sales in the U.S., once final approval for the OraTest® products are received from the FDA, and in Europe and Asia prior to the date we expect sales in the United States. The drug substance currently has expiration dates in 2004, 2005 and 2006. Previous testing indicates that the drug substance is stable and we expect to be able to extend the expiration dates of the entire drug substance through the date we expect sales in the United States. However, no assurance can be given that such future testing efforts will be successful. In addition, should FDA approval not be granted or be significantly delayed, it may not be possible for us to recover the value of this drug substance.
Daleco Capital Corporation
In June 1992, Daleco Capital Corporation formed a limited partnership known as Daleco Zila Partners II, L.P. (the “Partnership”). Zila and its officers have no partnership interest in the Partnership. The purpose of the Partnership was to provide the Company with a means to fund the marketing program for certain products. The original Partnership agreement provided for a minimum of $150,000 and a maximum of $1,562,500 to be raised by the sale of partnership units. Under the original agreement, the Partnership will expend up to 80% of the gross partnership proceeds for marketing and sales-related expenditures on behalf of the Company. In 1994, the Partnership agreement was amended to increase the maximum amount of marketing funds potentially available to the Company to be raised to $2,250,000. At July 31, 2003, approximately $1,820,000 has been spent.
We are committed to pay the Partnership a commission equal to 5% to 10% of the gross sales of certain of the Company’s products, until such time as up to three times the amount of funds expended on the marketing program by the Partnership has been paid to the Partnership. The Company has paid commissions to the Partnership of approximately $1,500, $11,000 and $15,000 for the years ended July 31, 2003, 2002 and 2001, respectively.
F-21
Operating Leases
We lease offices, warehouse facilities and certain equipment, under operating leases that expire through 2008. Future minimum lease payments under these non-cancelable leases are as follows:
2004 | | $ | 403,380 | |
2005 | | | 267,612 | |
2006 | | | 115,099 | |
2007 | | | 69,822 | |
2008 | | | 34,129 | |
2009 and beyond | | | 0 | |
| |
|
| |
Total | | $ | 890,042 | |
| |
|
| |
Rent expense for fiscal years 2003, 2002 and 2001 totaled $728,000, $407,000, and $475,000, respectively.
Contingent Warrants
In fiscal year 2002, we entered into a distribution agreement with WMTO, an international distributor of healthcare products, to obtain regulatory approval and to distribute the ViziLite™ and OraTest® products in certain Asian countries and in other Pacific Rim countries. Pursuant to the agreement, if WMTO meets certain purchasing milestones within defined time periods, then the Company is obligated to issue warrants to WMTO to purchase up to 600,000 shares of Zila common stock at $2.50 per share.
14. Related Party Transactions
In fiscal 2002, we paid $194,829 to Douglas, Curtis and Allyn, LLC, (“Douglas”), a corporation owned by a member of our Board of Directors at that time, Mr. Curtis Rocca. The payment was related to consulting work performed in connection with the sale of the ZDS businesses and pursuant to an engagement letter with Douglas dated March 15, 2001. In addition, Douglas was paid an advisory retainer of $60,000 during fiscal 2002. The agreements were terminated in July 2002. Mr. Rocca is no longer a director of the Company.
15. Employee Benefit Plan
We make available to all eligible employees, the Zila, Inc. 401(k) Savings and Retirement Plan (the “Zila Plan”). Participants may contribute, through payroll deductions, up to $12,000 of their basic compensation subject to Internal Revenue Code limitations. We may make matching or profit sharing contributions to the Zila Plan. During 2003, 2002 and 2001, we contributed approximately $191,000, $140,000 and $150,000, respectively, to the Zila Plan.
16. Segment Information
Our business is organized into three major groups, all of which have distinct product lines, brand names and are managed as autonomous business units. The following reporting segments have been identified for purposes of applying SFAS No. 131 “Disclosures about Segments of an Enterprise and Related Information”: Nutraceuticals, which includes Oxycal Laboratories, Inc. and its wholly-owned subsidiary, Zila Nutraceuticals, Inc.: Pharmaceuticals which includes Zila Pharmaceuticals, Inc. and the Zilactin® family of over-the-counter products, Peridex® prescription mouth rinse, the ViziLite® chemiluminescent disposable light product for the illumination of oral mucosal abnormalities, and the plastic molded products of Zila Swab Technologies, Inc., an Arizona corporation dba Innovative Swab Technologies (IST). The Zila Biotechnology Group is the research, development and licensing business specializing in pre-cancer/cancer detection through its patented Zila® Tolonium Chloride and OraTest® technologies and now manages the OraTest® product, an oral cancer diagnostic system, which is currently in FDA phase III clinical trials.
We evaluate performance and allocate resources to segments based on operating results. In August 2002, Consumer Pharmaceuticals and Professional Pharmaceuticals were combined into one Pharmaceuticals Group. Also, the Biotechnology Group was created by moving the OraTest® product FDA phase III clinical testing process out of Professional Pharmaceuticals and the Zila Tolonium Chloride technologies out of Corporate into Zila Biotechnology, Inc. We allocated the net gain of approximately $14.8 million derived from the settlement with our former CRO based principally upon the relative contributions of personnel from the Corporate and Biotechnology Segments in helping to achieve such settlement.
Segment information for 2002 and 2001 has been restated to reflect these organizational changes. The accounting policies of the operating segments are the same as those described in Note 1, “Nature of Business Activities and Summary of Significant Accounting Policies.”
F-22
The table below presents information about reported segments for each of the three years ended July 31 (in thousands):
| | Nutraceuticals | | Pharmaceuticals | | Biotechnology | | Corporate | | Total | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net revenues from continuing operations: | | | | | | | | | | | | | | | | |
2003 | | $ | 29,423 | | $ | 17,664 | | $ | 20 | | | | | $ | 47,107 | |
2002 | | | 19,559 | | | 15,206 | | | 107 | | | | | | 34,872 | |
2001 | | | 15,374 | | | 15,117 | | | 220 | | | | | | 30,711 | |
Income (loss) from continuing operations before income taxes and accounting change: | | | | | | | | | | | | | | | | |
2003 | | | 7,733 | | | 270 | | | 3,359 | | | 186 | | | 11,548 | |
2002 | | | 2,808 | | | (685 | ) | | (4,809 | ) | | (4,698 | ) | | (7,384 | ) |
2001 | | | 1,173 | | | 2,400 | | | (5,324 | ) | | (4,897 | ) | | (6,648 | ) |
Identifiable assets from continuing operations: | | | | | | | | | | | | | | | | |
2003 | | | 29,290 | | | 14,520 | | | 7,983 | | | 17,217 | | | 69,010 | |
2002 | | | 28,958 | | | 17,769 | | | 7,777 | | | 2,787 | | | 57,291 | |
2001 | | | 33,769 | | | 16,406 | | | 7,499 | | | 5,896 | | | 63,570 | |
Capital expenditures: | | | | | | | | | | | | | | | | |
2003 | | | 175 | | | 1,106 | | | 509 | | | 95 | | | 1,885 | |
2002 | | | 315 | | | 58 | | | 122 | | | 124 | | | 619 | |
2001 | | | 2,108 | | | 143 | | | 73 | | | | | | 2,324 | |
Depreciation and amortization: | | | | | | | | | | | | | | | | |
2003 | | | 1,001 | | | 596 | | | 715 | | | 120 | | | 2,432 | |
2002 | | | 1,235 | | | 1,376 | | | 737 | | | 120 | | | 3,468 | |
2001 | | | 1,160 | | | 1,217 | | | 338 | | | 460 | | | 3,175 | |
Revenues from customers attributed to all foreign countries were $8,948,000, $6,039,000 and $5,646,000 fiscal years 2003, 2002 and 2001, respectively.
17. Quarterly Financial Data (unaudited)
Quarterly financial information is presented in the following summary:
| | 2003 | |
| |
|
|
|
|
|
|
|
|
|
|
| |
| | Quarters Ended | |
| |
|
|
|
|
|
|
|
|
|
|
| |
| | October 31 | | January 31 | | April 30 | | July 31 | |
| |
|
| |
|
| |
|
| |
|
| |
Net revenues | | $ | 10,734,433 | | $ | 11,977,522 | | $ | 12,424,552 | | $ | 11,970,358 | |
Gross profit | | | 6,476,585 | | | 7,066,438 | | | 7,292,146 | | | 6,062,552 | |
Income (loss) from continuing operations before accounting change | | | (1,609,205 | ) | | (876,048 | ) | | (638,855 | ) | | 14,483,660 | |
Gain from discontinued operations | | | | | | | | | | | | 10,000 | |
Income (loss) before accounting change | | | (1,609,205 | ) | | (876,048 | ) | | (638,855 | ) | | 14,493,660 | |
Cumulative effect of accounting change | | | (4,084,193 | ) | | | | | | | | | |
Net income (loss) | | $ | (5,693,398 | ) | $ | (876,048 | ) | | (638,855 | ) | | 14,493,660 | |
Basic and diluted net loss per share: | | | | | | | | | | | | | |
Income (loss) from continuing operations before accounting change | | | (0.04 | ) | | (0.02 | ) | | (0.01 | ) | | 0.32 | |
Gain from discontinued operations | | | | | | | | | | | | 0.00 | |
Accounting change | | | (0.09 | ) | | | | | | | | | |
Net income (loss) | | | (0.13 | ) | | (0.02 | ) | | (0.01 | ) | | 0.32 | |
F-23
| | 2002 | |
| |
| |
| | Quarters Ended | |
| |
| |
| | | October 31 | | | January 31 | | | April 30 | | | July 31 | |
| |
|
| |
|
| |
|
| |
|
| |
Net revenues | | $ | 8,889,874 | | $ | 8,826,561 | | $ | 8,352,520 | | $ | 8,802,815 | |
Gross profit | | | 5,775,295 | | | 5,619,701 | | | 5,304,600 | | | 5,708,092 | |
Loss from continuing operations | | | (919,980 | ) | | (7,163,450 | ) | | (1,834,518 | ) | | (1,420,332 | ) |
Loss from discontinued operations | | | (7,248 | ) | | 123,707 | | | (287,712 | ) | | (500,751 | ) |
Net loss | | $ | (927,228 | ) | $ | (7,039,743 | ) | $ | (2,122,230 | ) | $ | (1,921,083 | ) |
Basic and diluted net loss per share: | | | | | | | | | | | | | |
Loss from continuing operations | | $ | (0.02 | ) | $ | (0.16 | ) | $ | (0.04 | ) | $ | (0.03 | ) |
Loss from discontinued operations | | | (0.00 | ) | | (0.00 | ) | | (0.01 | ) | | (0.01 | ) |
| |
|
| |
|
| |
|
| |
|
| |
Net loss | | $ | (0.02 | ) | $ | (0.16 | ) | $ | (0.05 | ) | $ | (0.04 | ) |
| |
|
| |
|
| |
|
| |
|
| |
18. Subsequent Events
On August 14, 2003, we settled claims brought against the Company by Matrixx Initiatives, Inc. (“Matrixx”) a major customer of our IST Products operations. Under the settlement, Matrixx withdrew all its claims against us and accepted our price increase on swabs and our current production level. Our existing contract with Matrixx was extended by 90 days to March 31, 2004, but it is unlikely that the contract will be renewed at that time.
On October 15, 2003, a mediation settlement was concluded affecting 875,000 shares delivered to Trylon and the 375,000 shares placed into escrow such that the contractual restriction on these shares will be only removed upon the achievement of certain government approval and other milestones and not at the earlier of 10 years following the closing date or the achievement of certain future sales milestones as was included in the original agreement. In addition, royalty payments were reduced.
In November 2001, we filed a suit for trademark infringement and trade secret misappropriation against Darrell Van Dyke and GMP Products, LLC (“Van Dyke”) in U.S. District Court for the Northern District of Illinois. In December 2002, the court entered a final judgment against us. Subsequently, the defendants brought a motion to recover their attorneys fees and other costs incurred in defending the action. On September 29, 2003, the court awarded $131,700 to the defendants. We intend to appeal this decision and our attorneys have expressed a high probability of success. Therefore, we have not accrued for this legal matter in fiscal year 2003.
F-24
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
Description | | Balance at
Beginning
Of Period | | Charged to
Costs and
Expenses | | Deductions | | Balance at
End of
Period | |
| |
|
| |
|
| |
|
| |
|
| |
Allowance for doubtful accounts receivable: | | | | | | | | | | | | | |
July 31, 2001 | | | 245,430 | | | 245,579 | | | 222,438 | | | 268,571 | |
July 31, 2002 | | | 268,571 | | | 95,882 | | | 231,834 | | | 132,619 | |
July 31, 2003 | | | 132,619 | | | 478,414 | | | 293,819 | | | 317,214 | |
Inventory reserve: | | | | | | | | | | | | | |
July 31, 2001 | | | 33,040 | | | 133,771 | | | 87,608 | | | 79,203 | |
July 31, 2002 | | | 79,203 | | | 466,085 | | | 252,563 | | | 292,725 | |
July 31, 2003 | | | 292,725 | | | 362,883 | | | 301,064 | | | 354,544 | |
Deferred tax valuation allowance: | | | | | | | | | | | | | |
July 31, 2001 | | | 948,000 | | | 1,422,000 | | | | | | 2,370,000 | |
July 31, 2002 | | | 2,370,000 | | | 9,247,000 | | | 2,515,000 | | | 9,102,000 | |
July 31, 2003 | | | 9,102,000 | | | | | | 3,843,000 | | | 5,259,000 | |
F-25
